Call premium is the value, or price, of a type of stock option referred to as a call option. An option is a financial instrument that gives the purchaser the choice to buy or sell 100 shares of a stock at a particular price, called a strike price. A put option gives the trader or investor the right to sell an option at the strike price, and a call option is the type of option that gives the trader or investor the right to buy the stock at the strike price. The call premium is determined by several contributing factors.
The primary factor that contributes to the premium of a call is the relationship of the price of the underlying stock to the strike price of the option. If the price of the stock is greater than the strike price, the option is said to be in the money and the call premium will contain every cent of the difference between the two prices. Generally, if the price of the stock is lower than the strike price of the option, the option is said to be out of the money and the premium will lose value rapidly with each cent decline in stock price.
A second contributing factor to a call premium is the time value. Every option has a maturity date, or expiration date, at which time the trader's right to buy the stock at the strike price expires. The time value factored into total premium of a call option will be greater the farther it is from the expiration date. For instance, if it is the month of February, a call option for Stock X that expires in June will be more valuable than the call option for Stock X with the same strike that expires in March. Options slowly lose their time value as their expirations draw closer; this is known as time decay.
Yet another contributing factor to the call premium is the volatility in the underlying market. Volatility is the current movement or expectation of movement in the price of a stock. If the price of Stock X is expected to experience a large increase in the near future due to an earnings announcement or the like, the implied volatility in the option will be high. A high implied volatility, especially to the upside, will add a lot value to the call premium.
Lastly, dividends paid on stocks directly influence the prices of the options for that stock. A call option is expected to fall in value with direct proportionality to the magnitude of the dividend payment. Puts gain value upon the payment of the dividend.
