How are option bid/ask (premium) prices determined?

Question

I bought some call options on a company with a strike price of $45. The premium was .55, I was wonder how is that premium price determined, and what will the premium price be if the stock is at $45.

Answer 1

The bid price is the most anyone is willing to pay for a contract. The ask price is lowest amount anyone will accept to sell a contract.

If you have an estimate about how volatile the price of the underlying will be prior to expiration you can calculate a theoretical price for the option using a option pricing model, such as the Black-Scholes model. There are option calculators, such as the one at

http://www.ivolatility.com/calc/?ticker=ge&R=0&top_lookup__is__sent=1

available on the web that will calculate that theoretical price.

A market maker will use the theoretical price then make his bid less than the theoretical price and make his ask more than the theoretical price. The difference between the two, the bid-ask spread, depends upon exchange rules, the option price and the amount of uncertainty about the future price.

You can use an options calculator to determine what the premium will be is the stock moves to $45 at different times and with different volatility projectections, know as "implied volatility" when pricing options.