Option Premiums


Hello everyone. This is Kirk, here again at optionalpha.com
and this is the video tutorial for option premiums. Again, we’re going to go right into it and
talk about some of the basics behind option premiums. We’re going to go back to our RB’s combo
coupon example because I love RB’s and this is a really easy way for you guys to understand
what an option premium is. Let’s just say again that we have this roast
beef combo coupon for $3.99. That’s what we can buy roast beef combo
right now at RB’s. If we go in there, we’ll give them the coupon,
we can buy it at $3.99. Let’s say that the regular cost of this
combo here is $6.99 for the example. I have this coupon in my possession and if
I want to sell it to you, I could add a premium onto the price that I have for that option
contract. Remember that this is just a contract right
here and I could sell this coupon to you for $1. Now, you’d still actually be ahead of the
game here because I’d sell it to you for $1, you would go in and pay RB’s $3.99, so your
total investment would be $4.99 and the price of it regularly is going to be $6.99, so you’re
still going to save $2 by buying this coupon for me if you couldn’t find it yourself
for example. That’s where the option premium comes into
play. It’s that extra price that you pay to acquire
that option contract because I’m not going to give this to you for free. It has value that’s left in it. There are two main factors that determine
an option contract premium and those two factors are intrinsic value or the value it has right
now and then the extrinsic value, the value that’s remaining and time decay and volatility,
etcetera. We’re going to go with an Apple stock example
like we’ve been doing and let’s look at some current options that are trading for
Apple. Now, I always use the last trade. Some people like to look at the bid and the
ask and try to figure out what the in between trade is, but when I’m looking at the price
of an option, I’m always going to look at the last trade or what the premium is for
that particular contract. You can see I’ve highlighted both of the
premiums for the calls which is located on the left side of this option pricing table
and then the puts which is located on the right side. And you can see that there are many different
prices or many different premiums because they all relate to where the strike price
is in relation to the current market. You can see that out of the money puts are
trading for $7.58 which is $758 and out of the money calls are trading for $5.95 which
is $595. These are all the different option pricing
premiums. This is what it cost to acquire any of these
strike price calls and puts on Apple. The premium isn’t fixed and changes constantly. Premium you paid today is likely going to
be higher or lower than premium yesterday or tomorrow. Going back to our example right here, these
are the premiums as of this time. I bet you if I pull up this pricing diagram
here today (and this a couple of days after I actually pulled this information when I’m
making this video) that these premiums would be wildly different and that’s because the
market is always changing. Everything that is a premium yesterday could
be higher or lower than tomorrow. When we talk about premiums, we want to talk
about and focus on the net debit or net credit. Again, net debit means that you’ve spent
money at the end of all of your transactions to enter the strategy. This could be a debit spread, an iron condor,
anything like that, a butterfly, a ratio spread, anything. Anything that you end up actually spending
money on is going to be a debit spread. To make money on these types of option strategies,
there must be an increase in the value beyond the price that you paid before expiration. That makes sense, right? If you buy a stock, the only way to make money
is that the value of the stock goes up. It’s the same thing with options. If you pay a premium and you actually outlay
that premium as a net debit, then to make money on that option trade, you need the value
of those options to go up. On the other hand, if you have a net credit,
this means that you begin with a credit of money to your account and that to make money
in this option strategy, you have to have decay in value below the price you paid at
or before expiration. Again, just like shorting a stock, when you
short a stock, you sell it high and you want the value to go lower, so you can buy it back
in. The same thing applies with options trading. If you have a strategy where you actually
get money at the end of the day, whether that’s a credit spread, an iron condor, naked puts
and calls, when you receive money or you receive that option premium, you can’t get any more
than that, but you can keep all of it if the value of those options decay and absolutely
completely disappear before expiration. That’s really the two big differences between
option premiums. You’re going to have premiums that you outlay
and those are net debits and then premiums that you take in which are net credits. Again, option premiums are very, very simple. They’re simply the price that you pay to
enter into a contract or the price that you receive to sell a contract or an options contract. Thank you for watching this video. If you guys enjoyed this video, as always,
right below this video are some links to some of the favorite social networks, so please
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