How six key variables determine the price of a stock option

Stock options are not random bets; their premiums are driven by specific, measurable factors. This video breaks down the mechanics behind option pricing, helping you understand how time, volatility, and market conditions influence the cost of these financial instruments.

The price of an option, or its premium, is dictated by six primary inputs. The underlying stock price is fundamental: as it rises, call premiums increase while put premiums decrease. Volatility—specifically the expected volatility of the underlying stock—is another major driver, where higher levels lead to higher premiums for both calls and puts.

Time and interest rates also play critical roles. A longer duration until expiration increases the premium, while higher interest rates boost call premiums and lower put premiums. Additionally, dividends affect pricing: higher dividends result in lower call premiums but higher put premiums. Understanding these relationships is essential for grasping how options are valued in the market.

Source: Stock Options Explained