Meta Pro Trader Options Education series.
The time premium is the amount buyers are willing to pay for the options contract above its intrinsic value on the chance that, at some time prior to its expiration, it will move into the money. Out-of-the-money options all carry time premium since their intrinsic value is zero, as is that of at-the-money options.
The time premium for the in-the-money options contract is the amount that exceeds the option’s intrinsic value and reflects the possibility that the options contract may move deeper into-the-money. The time value of an options contract shrinks as the expiration date approaches, with less and less time for a major change in market opinion, and a decreasing likelihood that the options contract will increase in value.
As prices fluctuate more widely and frequently, the premiums for options on futures increase, since the probability of the options contract attaining intrinsic value or moving deeper into the money increases. Accordingly, options writers demand higher premium payments. If market volatility declines, premiums correspondingly decline.