When engaged in Forex Option and option trading, the premium that the buyer tenders to the seller is automatically computed according to certain formulas. There are different factors that affect the price of an option and the rate of the premium. First is the difference between the spot or market rate and the strike rate. This will be taken into account when calculating the premium to be paid. The higher or greater the difference between the spot rate and the strike rate the lower or lesser the price of the option because of the low chance or probability of hitting the strike price.
Second is the time span or period upon the start of the agreement until its expiration. The longer the life span of the option, the more expensive or costly is the premium to be paid by the buyer to the seller. This is because the value of an option decreases as the date of expiry of the agreement nears. An option actually becomes valueless after the date of expiration, necessarily so these options are also termed as "wasting assets" or assets that decrease in value overtime.
Third is the volatility or unpredictability of the market. This is probably the most important factor of all in Forex Option and option trading. If the volatility is high, the seller takes a bigger risk and the buyer will necessarily pay a larger premium in order to cover that risk. If the volatility is low, then the seller takes a lesser risk and the buyer will pay a lesser premium. Forex Option and option trading in general, indicates that the higher the volatility the greater the price of the option and the lower the volatility the lesser the price of the option.
