At first glance, the price of a call option might not make a lot of sense. On the listed options chain for a particular stock, there will be call options priced at less than $100 per contract up, and others that cost thousands of dollars. The factors affecting the price of a call option allow you to decide if buying or selling a particular call makes sense in your trading strategy.
The intrinsic value of a call option is a result of two factors: the option strike price and the current share price of the underlying stock. The strike price is the share price at which the call option holder will buy the stock if the holder elects to exercise the option. If the stock price is above the strike price, the option has intrinsic value, or is in-the-money, by the amount the stock is higher than the call strike price. For example, a stock currently trades for $30 per share, and you are looking at a call with a strike price of $25 and the option priced at $7. Of the $7 option price, $5 is intrinsic value.
The portion of an option's price that is not intrinsic value is time premium. This is the price a buyer pays for the rights given by a call option contract. The amount of time premium will be higher for an option with a longer time to expiration than on an option that expires in a nearer month. The time premium on an option declines to at or near zero as the expiration date approaches. Call options that do not have intrinsic value are out-of-the-money, having prices consisting entirely of time premium.
The amount of time premium included in an option price is determined by the volatility of the underlying stock price. For two stocks with options expiring in the same month, the call option time premium on the more volatile stock will be higher than the less volatile stock. A common metric shown with options prices is the implied volatility. This number shows the amount of expected stock price volatility based on where the market has placed the call option prices. Volatility pricing means you will pay more for call options on volatile stocks than you will for stocks with lower expected price movements.
Option Prices and Costs
The price of a call option is related to the share price of the underlying stock factoring in the strike price, time to expiration and expected volatility. A single call option contract covers 100 shares of the underlying stock, so the cost of an option is 100 times the quoted price. If an option is quoted at $7, the cost of that option would be $700 plus commissions. If the option has $5 of intrinsic value, a contract in you brokerage account is $500 in-the-money.