Options Foundations · Options Trading Guide
Premium is the price of an option, not its potential profit. Learn to separate intrinsic value, time value and the cash direction of a trade.
Break the premium into components
Intrinsic value is the positive exercise value. For a call it is the amount the underlying exceeds the strike, floored at zero. For a put it is the amount the strike exceeds the underlying, also floored at zero. Extrinsic value is the premium above intrinsic value. Before expiration, time, volatility and other inputs affect that remaining component. An option can be valuable even when it has no intrinsic value.
Calculate an example in consistent units
A stock trades at $52 and its 50 call costs $3.20. Intrinsic value is $2 and extrinsic value is $1.20 per share. One standard contract costs $320. At expiration with the stock at $53, the option is worth $300, so the buyer loses $20 before costs despite finishing in the money. The expiration breakeven is $53.20. Before expiration, a profitable sale can occur at a different underlying price because extrinsic value remains.
Trace debits and credits
Buying an option normally creates a debit. Selling one normally creates a credit. In a spread, combine all opening cash flows to obtain the net debit or credit. Buying a call for $4.50 and selling another for $1.70 creates a $2.80 debit per share, or $280 for a standard one by one spread. Debit and credit are not additional contract types alongside calls and puts. They describe the net cash flow.
Keep valuation and realised results separate
For a purchased option, a closing sale at $4 after an entry at $3 produces $1 gross profit per share. For a written option, buying it back at $4 after collecting $3 produces a $1 loss. Subtract commissions, exchange fees and other applicable costs. Record open obligations alongside received cash so a large premium receipt cannot conceal a larger adverse change in the position.
Try it yourself
You receive $1.80 to open a credit spread and later pay $0.65 to close it. Total costs are $8 for one standard spread. What is net profit?
Show the worked answer
The premium difference is $1.15 × 100 = $115. After $8 of costs, net profit is $107.
Further reading
Educational material. Examples and rates are hypothetical, not trade recommendations. Product terms, eligibility and risks vary by venue and jurisdiction.
