Option Premium

The premium is the price of an option: what the buyer pays the seller to acquire the right the contract carries. It is paid up front, it is not returned if the option is never exercised, and it is the buyer's maximum loss on the contract itself. For the seller it is the entire compensation for taking on an obligation whose eventual cost is unknown at the moment the trade is struck. What the premium is made of is worth separating. Part of it reflects how far the market rate already sits on the favourable side of the strike; the rest reflects the possibility that it gets there, or gets further, before expiry — which is why an option with no advantage today still costs something. The premium therefore moves with the market rate, with the time remaining and with how much movement the market is pricing, the last of which is the quantity currency options are actually quoted in. Settlement conventions differ, so which currency the premium is paid in and when it settles are terms of the individual contract rather than universal rules.