Option price — what is it?
Initially, the word “option” referred only to a type of security. Such instruments are the central object of buying and selling, which means they have their own price. It seems simple, but the option price is a concept that cannot be called a price in the usual sense. An option is both a service and a product at the same time. This is what defines the main specificity of this type of security.
What is an option price?
First, let us understand what price means in the usual sense. Price is the exchange ratio of an asset for money. This measure applies to all areas of the financial market, whether it is simple “buyer–seller” relations or the exchange of one currency for another. In the latter example, the price of an asset (currency) is its exchange rate.
An option is both a security and a contract between two parties. One party has the right to buy or sell a certain asset at a fixed price, while at the same time assuming no obligations. The other party guarantees that within a specified period, at the request of the security holder, it will definitely sell or buy the underlying asset at the agreed price, regardless of how much it differs from the market value at the time of exercise. As you can see, one party (the option seller) assumes obligations but has no rights, while the other (the option buyer, the investor) has rights but no obligations.
The existence of such an unequal agreement is possible due to a one-time payment received by the seller at the moment the deal is concluded. The option price is exactly the amount paid by the buyer to the seller.
How does the option price differ from the premium?
Roughly speaking, the option price and its premium are the same thing. If, at the moment of concluding the option contract, the buyer paid the seller a $100 premium, then the option price will accordingly also be $100.
However, there is still a difference between the concepts of “price” and “premium.”
If an option is considered specifically as a security, that is, a document that has its own value regardless of the conditions described in it, then the word “price” is more appropriate.
Commodity options most often act as securities. They give their holder the right to buy or sell goods at a fixed price, which is usually always favorable for the buyer. The seller issues such contracts mainly to attract buyers and quickly receive the required amount. The main idea of such contracts is the very fact of sale. It turns out that the security itself is the product, and therefore the concept of “option price” is more appropriate. 
Exchange-traded options are more often considered as a transaction between two parties. Such contracts quite often describe, in addition to the buyer’s rights and the seller’s obligations, the conditions that must be met for the option to be exercised. This explanation will be clearer to those who know what binary options are.
The option itself ceases to be something valuable. A person seeks not to obtain it, but to gain profit from correctly buying or selling the contract. The main instrument for making profit becomes the seller’s obligation. In essence, this obligation is the most important part of exchange-traded options. For fulfilling obligations, a person receives a premium, not a price. Therefore, in exchange trading, the concept of a premium is used more often.
Nevertheless, despite these differences, using the words “price” and “premium” is acceptable and correct in both cases.
What is the option’s exercise price?
The concept of price applies not only to the option itself but also to the underlying asset. The strike price, or exercise price, is the price specified in the contract at which the seller of the security undertakes to sell or buy the asset.
As a rule, it is set taking into account the average market value of the asset at the moment. At the same time, the option buyer either hopes to make a profit from the difference between the market price and the exercise price, or to insure investments in the underlying asset by selling it at a fixed price in case of a decline in value.
How is the option price calculated?
The price of any product must be supported by something; it is never taken out of nowhere. For example, food prices depend on the cost of raw materials, services depend on the qualifications and experience of the provider. In addition, pricing is always guided by market conditions: the level of competition and demand.
Since the formation of options exchanges, various analysts have been searching for the most suitable model for calculating the price of such contracts. Usually, in the case of commodity options, a “fair” pricing model is used, while for exchange-traded options, a model based on asset parameters and the risk level of both parties is applied. It is commonly called modern, sometimes binary.
“Fair” pricing model
The word “fair” does not mean that such a model is the only correct one. It is called fair because, on average, both the seller and the buyer receive equal profit from concluding the contract. This model is applicable only to commodity options, since in this case both parties want to profit precisely from the sale (purchase) itself, not from the process of its execution. The seller and the buyer are equally interested in the contract, and for a successful transaction, one side must adapt to the other.
Modern pricing model
With the rise of exchange trading, a completely different pricing model emerged. Each party to the contract strives to obtain maximum profit. Both participants will get either everything or nothing. Of course, there can be no talk of a fair price here. The seller tries to make it as profitable as possible for himself, but at the same time is constrained by market influence. The buyer also strives for maximum benefit but is restrained by possible risk.
In barrier and binary options, everything is even simpler. The buyer determines how much he is willing to pay for the option. His potential profit depends on this amount. On the other hand, as the price increases, the risk assumed by the buyer also grows.