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The option premium is the amount of money paid by the buyer of an option to its seller (or option writer). It is the price paid for the right to buy or to sell an underlying asset provided by the option.
Although each option on a stock usually gives the right to buy or sell 100 shares, the option premium is set on a per share basis. A premium of $1.50 on a Bombardier stock option implies that the option contract will cost $150 (i.e., $1.50 × 100).
The option premium is the sum of two components: the intrinsic value (which is the positive difference between the security price and the strike price for a call option or between the strike price and the security price for a put option) and the time value (which is the value attributed to the time remaining until the expiration of the option).
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The option premium is the maximum profit that the writer can expect from its transaction with the buyer. This maximum profit occurs when the option he has written expires unexercised. For a speculator, the premium can be seen as an investment from which he expects to make a profit through the exercise of the option.
He incurs a loss equivalent to the amount of this premium if the option ends unexercised. However, for someone seeking a protection against a given risk, it is analogous to an insurance premium paid to an insurance company.
