UK Accounting Glossary
An amount paid in addition, or extra.
In options trading, the premium is the total price of an option. The premium is the compensation an option writer receives for assuming the risk of writing the option. From the buyer’s perspective, the premium is the cost for holding the right to buy or sell the underlying asset to the writer. If the option is exercised, the premium offsets the writer’s losses. On the other hand, if the option is not exercised, the premium is the writer’s profit. A premium is calculated by adding the intrinsic value of the option to its time value. The intrinsic value component of the premium is the amount by which the option is in-the-money. The time value component of the premium is chiefly determined by the amount of time left until the option expires – along with the volatility and dividends of the underlying security as well as the current risk-free interest rate (i.e. T-bill rate).
If you don’t pay your premiums on time, your policy will lapse.
It may be more convenient for companies to pay their premiums annually, and simplify their monthly budgeting process.
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This glossary post was last updated: 23rd December 2018.