Deep Dive · Lesson 4
Premium and
Intrinsic Value
Big Idea
- An option has a price called the premium — what the buyer pays to own the option contract.
- Intrinsic value is the value an option would have if it were used right now.
- Premium = what the option costs. Intrinsic value = what the option is worth right now based on the stock price and strike price.
Start With the Premium
What Is the Premium?
The premium is the price of the option contract. The buyer pays it, and the seller receives it.
It is not a deposit — if the option expires worthless, the buyer does not get it back.
Example
Acme shares trade at $50. You buy a call — the right to buy 100 shares at $55. The option costs $200. That $200 is the premium.
Why premium matters: It is not enough for the stock to move in the right direction. The stock often has to move enough to overcome the premium paid. "The premium is the entry fee to the options arena."
Intrinsic Value
What Is Intrinsic Value?
Intrinsic value looks at: the current stock price, the strike price, and whether the option is a call or a put. It does not include the value of extra time.
Simple question: "If this option were used right now, would it be worth anything?"
Call
Market price is above strike price → call has intrinsic value
Put
Market price is below strike price → put has intrinsic value
Call Example
Acme at $60, call strike $50
$60 − $50 = $10 / share
$10 × 100 = $1,000 intrinsic value
Put Example
Acme at $40, put strike $50
$50 − $40 = $10 / share
$10 × 100 = $1,000 intrinsic value
When Intrinsic Value Is Zero
Intrinsic Value Cannot Be Negative
If using the option right now would not be helpful, its intrinsic value is simply zero — not negative.
Call with $0 Intrinsic Value
Acme at $40, call strike $50. Buying at $50 when the market is $40 does not make sense → intrinsic value = $0.
Put with $0 Intrinsic Value
Acme at $60, put strike $50. Selling at $50 when the market is $60 does not make sense → intrinsic value = $0.
An Important Distinction
Intrinsic Value Is Not the Same as Premium
The premium is the market price of the option. Intrinsic value is only one part of that price. An option can have intrinsic value, time value, both, or neither if it expires worthless.
Example
You buy a call for $700, strike $50, Acme at $55.
Intrinsic value: $55 − $50 = $5 / share × 100 = $500
Premium paid: $700
The extra $200 is not intrinsic value — it relates to other factors, especially time value.
Interactive Checks
Check 1 of 5
Acme shares are trading at $60. The call strike price is $50.
Does this call option have intrinsic value?
Check 2 of 5
Acme shares are trading at $40. The call strike price is $50.
What is the intrinsic value of the call option?
Check 3 of 5
Acme shares are trading at $40. The put strike price is $50.
What is the intrinsic value of the put option?
Check 4 of 5
You buy an option for $300.
What is the $300 called?
Check 5 of 5
You buy a call for $700. Strike price is $50, stock trades at $55, 100 shares.
What is the intrinsic value of the option?
Common Beginner Mistakes
- ❌ Thinking premium and intrinsic value are the same. The premium is the option's price. Intrinsic value is only the value the option would have if used right now.
- ❌ Forgetting the premium paid. Being directionally right does not always mean the trade is profitable. The move has to be large enough, fast enough, and valuable enough to overcome the premium paid.
- ❌ Thinking intrinsic value can be negative. If the option would not be useful right now, its intrinsic value is simply zero.
Quick Memory Tool
- Premium = the price of the option
- Intrinsic value = the useful value right now
- For calls: intrinsic value exists when market price is above strike price.
- For puts: intrinsic value exists when market price is below strike price.
- If using the option would not help, intrinsic value is zero.
Next Lesson
Time value — An option can have value even when it has no intrinsic value. That extra value often comes from time, possibility, and uncertainty.