What are the factors that affect the value of the premium of an Option?

7 main factors influence the value of the option premium:

• Price of the underlying asset: If the price of the underlying asset increases, the premium value of the call option increases, while that of the put option decreases and vice versa.
• Intrinsic value of the option: This refers to the value of an option if it is exercised today and is calculated as the difference between the spot price and the strike price of an option. An increase in the intrinsic value reduces the value of the call option and increases the value of the put option.
• Volatility of the underlying share: The probability of price fluctuations in the underlying share also affects the value of the option. The higher the volatility, the higher the premium.
• Option moneyness: In-the-money strike prices have higher premiums, while out-of-the-money strike prices have lower premiums. As a result, calls become more expensive when the strike price falls. Similarly, puts become more expensive when the strike price rises.
• Time to expiration: The time remaining until an option expires also affects the premium. The closer the expiry date, the lower the premium and vice versa.
• Risk-free interest rate: The prevailing interest rates in a country have an indirect and nominal impact on the premium structure. High interest rates mean high premiums and vice versa.
• Payouts: Dividends announced by the company during the life of an option also affect the premium price. As per SEBI regulations, option prices are adjusted for dividend-free days if a dividend of more than 10% is announced. A higher dividend lowers the premium and vice versa.

Effect of Market Factors on Call Option Price and put Option Price