# What You Need To Know To Profit From Options Premiums…

If you’re new to the world of options, then you may be wondering what you need to know to profit from options premiums.

It’s crucial to know for practically every trading scenario, so it’s worthwhile to make sure you have a firm grasp on the concept.

Let’s take a look…

### What Is An Options Premium?

A variety of factors determine premiums. The most important include:

— The intrinsic value of the option. When an option is “in-the-money,” the intrinsic value is the difference between the market price of the underlying security and the option’s strike price. When an option is “out of the money,” the intrinsic value is \$0.

— The time value of the option. Time value decreases as the expiration date nears. This is because there is less time for the intrinsic value to increase. Time value reaches \$0 on the option’s expiration date.

— The implied volatility of the option. The portion of the premium associated with the implied volatility will increase as the volatility of the underlying security increases. This is because the chance of reaching the strike price is higher for more volatile securities.

Several formulas determine options premiums, including the Nobel Prize-winning Black-Scholes formula.

In the most simplified terms, the premium can be found with an equation that considers several factors:

Premium = Intrinsic Value + Time Value + Implied Volatility

To find the intrinsic value of the option, find the difference between the market price of the underlying security and the option’s strike price. For a call option, subtract the strike price from the current market price of the underlying security. A call with a strike price of \$10 on a stock, for example, with a market price of \$15, has \$5 of intrinsic value. For a put option, subtract the market price of the underlying security from the strike price. A put with a \$12 strike price on a stock with a market price of \$9 has \$3 of intrinsic value. Again, the intrinsic value for out-of-the-money options is \$0.

Determining the time value and implied volatility is more difficult. There are a number of calculators available on different websites and in software packages that can do this.

### How To Profit From Options Premiums

When buying options, most traders begin their analysis by finding securities in which they expect to see large price moves. They will then review the available options contracts on that security, comparing the actual premiums to what they believe the premiums should be. Like investing in stocks, value is an important consideration. Buying undervalued options would be preferable to buying overvalued options.