In order to purchase a right to do something you must pay cash upfront. The same happens with options. The buyer of an option pays the premium and the writer or seller earns it. The value of the premium is constantly changing and in order to make profit in options trading you can trade this premium, buy and sell it or short sell it (writing) and close your position before the expiration date. You don’t have to exercise it to make money. Concisely, premium is the price of an option.

But how its value will change and why?

In call options

Suppose you are long a call option in ORCL stock. The premium you have paid to own the right is $1/share. Suppose also that the strike price is $30 and the stock price now is at $29. What will happen to the premium if the stock price goes to $32? The value of the premium will be higher now because you can exercise the call if you want and make $2/share gross profit. This profit potential is priced in the premium from market participants, so its value gets higher. What will happen if ORCL price goes to $25? The value of the premium will be lower because market participants perceive that this call with strike price at $30 is difficult to produce any gains and it might expire worthless. This notion is mirrored in the new premium which is now lower. If you were the writer of this call the loss in the value of the premium would be desirable because as a short seller you have sold the call for $1 and now you can buy it at a lower price and close your position on profit.

In put options

Suppose you are long a put option in MSFT stock. The premium you have paid to own the right is $2/share. Suppose also that the strike price is $35 and the stock price now is at $34. What will happen to the premium if the stock price goes to $31? The value of the premium will be higher now because you can exercise the put if you want and make $4/share gross profit. All you have to do is buy 100 shares of MSFT for $31 at market prices and sell it to $35 (strike price). This profit potential is priced in the premium from market participants, so its value gets higher. What will happen if MSFT price goes to $40? The value of the premium will be lower because market participants perceive that this put with strike price at $35 is difficult to produce any gains and it might expire worthless. This notion is mirrored in the new premium which is now lower. If you were the writer of this put the loss in the value of the premium would be desirable because as a short seller you have sold the put for $2 and now you can buy it at a lower price and close your position on profit.

There are much more parameters that define premium except the underline security, which are analyzed in the following sections.