How Options Are Priced - The Six Inputs That Move a Premium

Reviewed by Leon Moyer - Published October 9, 2026 - Last reviewed October 9, 2026

An option's price depends on six inputs: the stock price, the strike price, the time to expiration, implied volatility, interest rates and expected dividends. The market sets the actual price through supply and demand, but traders and pricing models tie it to these six.

Knowing which way each input pushes the price is what lets you predict how an option will behave before you own it, and explain it afterward when the stock moves one way and your option moves the other.

How are options priced?

Options trade in a market like shares do, so the price you actually pay is whatever buyers and sellers agree on. But those prices are not random. Market makers and other traders use pricing models, which turn the six inputs into a theoretical value, as a reference point. The models do not set the price, though: as the OIC's Black-Scholes guide puts it, market forces determine actual premiums, not formulas.

The best known is the Black-Scholes model, published in 1973. It takes the six inputs and returns a theoretical price. The free profit calculator uses it for its Auto premium, and so does every model price in this module. The same guide notes that American-style equity options are typically priced with a binomial model because of their early exercise feature. Listed U.S. stock options allow early exercise, so these are illustrative model values, not executable quotes. Black-Scholes makes simplifying assumptions (volatility stays constant, and the option can be exercised only at expiration), so real prices differ from it, but it captures how the inputs push a price around.

Stock price, strike and expiration can be observed directly; future dividends and the appropriate interest rate require assumptions. Implied volatility is then inferred from the option price using those inputs. That is why the next lesson, What Is Implied Volatility?, is devoted to it.

What affects option prices, one input at a time?

The cleanest way to see each input's effect is to change one and hold the rest still.

Here is what each row says.

Stock price

When the stock rises, calls gain and puts lose, and the reverse when it falls. A $2 rise moved the call from $181 to $305 and the put from $162 to $87. The option did not move the full $200, because it is not yet certain to finish in the money. Delta measures how much an option's model price changes for a $1 stock move, with other inputs held fixed.

Strike price

The strike is fixed once you own the option, but it is the first choice you make. With XYZ at $50, a 55 call costs just $0.33, because the stock has to climb $5 before it has any intrinsic value. A 55 put costs $5.13, because it already has $5.00 of intrinsic value. Lower strikes make calls more expensive; higher strikes make puts more expensive.

Time to expiration

More time means more chances for the stock to move, so otherwise comparable options generally command more premium with more time left. This is not universal for European-style options: a deep in-the-money European put, for example, can become more valuable as expiration approaches because the strike payment is less discounted. With 60 days instead of 30, the call is worth $2.60. With only 10 days left and the stock unchanged, the call falls to $1.02 and the put to $0.96. That loss is time decay, from Intrinsic and Extrinsic Value.

Implied volatility

Higher implied volatility makes both calls and puts more expensive, because a bigger expected move raises the chance of a big payoff in either direction, while a buyer's loss is still capped at the premium. Raising it from 30% to 45% lifted the call from $181 to $266 and the put from $162 to $248. Dropping it to 20% cuts the call to $1.24. Volatility is often the input that surprises new traders most.

Interest rates

Higher rates nudge calls up and puts down. In the model, the reason is that a call lets you delay paying for the shares, and a put delays receiving the cash from selling them. For a 30-day option the effect is small: cutting the rate from 4.5% to 0% moved the call by only $9, and raising it to 6% prices the call at $1.84 and the put at $1.59. At a 0% rate, this at-the-money call and put cost exactly the same.

Dividends

When a company pays a dividend, its share price typically drops by about the dividend amount on the ex-dividend date. So, all else equal, an expected dividend before expiration lowers call prices and raises put prices. The profit calculator's model has no dividend input, so its prices assume none.

Which inputs matter most?

For most options you will trade, three inputs do nearly all the work: the stock price, time and implied volatility. They also often pull in different directions at once. A stock can rise while time passes and implied volatility falls, and the option's price is the net of all three. That is how a trader can be right on direction and still lose money.

The OIC's option price behavior guide summarizes several of the same effects.

In one sentence: all else equal, calls gain from a higher stock price, higher volatility and higher rates, while puts gain from a lower stock price, higher volatility and lower rates; more time generally helps both.