An option premium has exactly two parts: intrinsic value, which only in-the-money options have, and time value, which is any premium in excess of intrinsic value before expiration, as OCC's options pricing page defines them. On a Cboe index option the conversion into dollars is fixed at a $100 multiplier where one index point equals $100, so a Mini-SPX call quoted at 12.40 costs $1,240 per contract, per Cboe's XSP specifications. The strike is the condition that decides how that $1,240 splits.

Intrinsic value is the part that already exists

Intrinsic value is the difference between the current price of the underlying security and the strike price, and only in-the-money options have it: a call is in the money when the underlying trades above the strike, a put when the underlying trades below it, states OCC's pricing page. An at-the-money or out-of-the-money option has no intrinsic value at all, and its quoted premium is time value from top to bottom. Intrinsic value also floors at zero rather than running negative: a call struck above the index and a put struck below it are both worth zero intrinsically, however far out of the money they sit.

That is why a premium can be large on a contract with nothing in the money. The number on the screen is not a measure of how far ahead the position is.

The dollar size of intrinsic value comes from the contract, not from the quote. Cboe's XSP specifications set the multiplier at $100 with a minimum tick of 0.01, worth $1.00, across all series including LEAPS, and put the approximate notional size of one XSP contract at $65,000 when the S&P 500 is 6,500. Cboe's SPX specifications use the same $100 multiplier on the full-size contract, with a minimum tick of 0.05 ($5.00) below 3.00 and 0.10 ($10.00) for all other series, and an approximate notional of $650,000 at that same index level.

Time value is the rest, and it ends at zero

Time value is what an option buyer pays above intrinsic value, and the longer the time available for market conditions to work in the buyer's favor, the greater it is, according to OCC's pricing page. The same page puts volatility in the premium directly: higher volatility estimates mean greater expected fluctuations in either direction, which generally produces higher premiums for puts and calls alike, and the effect is most noticeable on at-the-money options. Dividends and interest rates have a small but measurable effect, reflecting the cost of carrying shares.

Two of those inputs move with the market and one does not. The clock only runs one way, and at expiration the time-value component is gone, leaving intrinsic value or nothing. That is true of every series on the board at the same moment, whatever the strike. What happens to each part at that moment is worked through in expiration is a deadline with consequences.

A rising premium therefore says nothing on its own about direction. It can come from the underlying moving, from a volatility estimate widening, or from neither, which is the distinction drawn in a rising market can still be volatile.

Example: an XSP call quoted at 12.40

Assume the S&P 500 at 6,500, which puts the Mini-SPX index at 650.00, and an XSP 645 call quoted at 12.40. Those two levels are the assumed figures; the multiplier, the tick size and the notional come from Cboe's XSP specifications.

Intrinsic value: 650.00 - 645 = 5.00 index points, or 5.00 x $100 = $500.

Time value: 12.40 - 5.00 = 7.40 index points, or 7.40 x $100 = $740.

Total premium: 12.40 x $100 = $1,240, which is $500 + $740. Intrinsic value is about 40 percent of what the buyer pays; the other 60 percent is time value that expires. One tick of 0.01 moves the contract by $1.00, so a quote of 12.41 is a $1,241 contract.

Now move the strike without touching anything else. An XSP 655 call with the index at 650.00 is out of the money, so intrinsic value is zero and the entire quoted premium is time value. The notional exposure behind either contract is unchanged at roughly $65,000.

The premium is what the holder pays in full and the largest amount the holder can lose on the option itself; the writer's side of that trade is open-ended and margined, which is set out in rights on one side, obligations on the other.

Source references

Primary sources used for this guide. Follow the links for the original scope, definitions and conditions.