Buying premium in the options market can feel like the fastest way to grow your trading account. The allure of limited risk and potentially unlimited reward draws many traders to long calls and puts. However, purchasing options premium is inherently challenging because you are fighting against time decay and implied volatility every single day you hold the position.
Before you risk your capital on buying premium, you need a solid plan. Too many traders skip the preparation step, click “buy,” and then watch helplessly as their options bleed value. The good news? A simple pre-trade checklist can dramatically improve your results.
In this guide, we will break down the five critical questions every options trader should ask before buying premium. Whether you are a beginner looking to understand the basics or an experienced trader refining your strategy, answering these questions will help you make more informed decisions and improve your chances of success.
What Does “Buying Premium” Actually Mean?
Before diving into the questions, let’s clarify what buying premium actually means. When you buy an options contract (either a call or a put), the price you pay is known as the options premium. This premium consists of two components: intrinsic value (if the option is in-the-money) and extrinsic value (time value plus implied volatility).
When you buy premium, you are essentially paying for the right to control the underlying asset for a specific period. Your maximum risk is limited to the premium you paid. However, the challenge is that extrinsic value decays every day, meaning the stock must move enough in your favor to overcome that erosion.
Think of it like buying a concert ticket months in advance. The ticket has value because the event hasn’t happened yet. But if the concert gets closer and you still haven’t decided to go, the resale value might drop. Options work similarly, with time eroding the “anticipation value” built into the price.
Key Takeaway
Buying premium means purchasing calls or puts. Your risk is capped at the premium paid, but you must overcome time decay and potential volatility contraction to profit.
1. What is the Implied Volatility (IV) Rank?
The first question you should always ask before buying premium is: “Is the implied volatility high or low?” Implied volatility (IV) represents the market’s expectation of future price movement. When IV is high, options premiums are expensive. When IV is low, premiums are relatively cheap.
However, simply looking at the raw IV percentage isn’t enough. You need context. A stock with 40% IV might be cheap for a biotech but expensive for a utility company. This is where IV Rank and IV Percentile come into play.
IV Rank tells you where the current IV sits relative to its 52-week high and low. An IV Rank of 80% means the current IV is near its yearly high, making options expensive. An IV Rank of 20% means IV is near its yearly low, making options cheaper to purchase.
IV Percentile, on the other hand, tells you what percentage of days in the past year had lower IV than today. If the IV Percentile is 90%, it means IV was lower than today’s level on 90% of trading days, confirming that current premiums are elevated.
Key Takeaway
As a general rule, you want to buy premium when IV Rank is low (typically below 25-30%). Buying options when IV is high exposes you to the risk of “IV crush,” where the premium collapses even if the stock moves in your desired direction.
Before buying a call or put, check the IV Rank on your trading platform. Most modern platforms like thinkorswim (Schwab) display IV Rank prominently. If it’s elevated, you might want to reconsider buying premium and instead look at strategies that benefit from falling volatility, such as selling credit spreads.
Quick IV Rank Reference
Here’s a simple framework for interpreting IV Rank when considering buying premium:
- IV Rank 0-25%: Favorable for buying premium (options are cheap)
- IV Rank 25-50%: Neutral territory (proceed with caution)
- IV Rank 50-75%: Unfavorable for buying (consider selling strategies instead)
- IV Rank 75-100%: Avoid buying premium (options are expensive)
2. How Much Time to Expiration Do I Need?
Time is the enemy of the options buyer. Every day that passes, the extrinsic value of your option decreases. This phenomenon is known as time decay, and it is measured by the options Greek called Theta.
Theta decay is not linear. It accelerates as the option gets closer to expiration. An option with 60 days to expiration will lose value much slower per day than an option with 5 days left. The decay curve resembles a hockey stick, with the steepest decline occurring in the final two weeks before expiration.
Many beginner traders make the mistake of buying short-term options (like weeklys) because they are cheaper in absolute dollar terms. However, these options suffer from rapid time decay, requiring the underlying stock to make a massive move almost immediately for the trade to be profitable.
⚠️ Risk Warning
Buying short-term options (0-14 days to expiration) carries a very high risk of expiring worthless due to aggressive Theta decay. You need impeccable timing to profit from these trades.
When buying premium, it is usually wiser to buy more time than you think you need. Aim for 30 to 60 days to expiration (or more) as a starting point. This gives your thesis time to play out without the constant pressure of accelerating time decay.
Yes, the premium will cost more upfront, but your probability of success increases significantly. Think of it as paying a little extra for insurance against bad timing. The stock might move in your direction on day 25, and you want to still have meaningful value in your option when it does.
Matching Expiration to Your Thesis
A good rule of thumb is to give yourself at least twice the amount of time you expect the move to take. If you think a stock will rally over the next two weeks based on a technical breakout, consider buying an option with at least 30-45 days to expiration. This buffer protects you if the move takes longer than anticipated.
3. What is the Specific Catalyst for Buying Premium?
Buying options premium requires the underlying stock to move, and it needs to move quickly enough to overcome time decay. Stocks rarely make significant moves without a reason. Therefore, you must ask: “What is the catalyst that will drive the stock price?”
A catalyst is an event that has the potential to cause a sharp change in the stock’s price. Without one, you are essentially hoping for random market fluctuations to bail you out, which is not a strategy. Common catalysts include:
- Earnings reports and revenue guidance
- FDA drug approvals or clinical trial results
- Macroeconomic data releases (CPI, Fed meetings, jobs reports)
- Product launches or major company announcements
- Technical breakouts from well-defined chart patterns
- Sector rotation or major index rebalancing
If you are buying premium without a clear catalyst, you are relying entirely on hope. A well-defined catalyst provides a reason for the stock to move in your anticipated timeframe, giving your trade a logical foundation.
However, be cautious when buying premium directly ahead of a known binary event like earnings. As discussed in our guide on earnings implied volatility, premiums are often inflated right before the event. If you buy options right before earnings, you risk suffering an IV crush the next morning, even if you guessed the direction correctly.
Pro Tip
The sweet spot for catalyst-driven trades is often buying premium 2-4 weeks before the event, when IV hasn’t fully expanded yet. This lets you benefit from both the directional move and the rising IV as the event approaches.
4. What is My Exact Breakeven Point?
When you buy a stock, your breakeven point is simply the price you paid. Options trading is different. Because you pay a premium, the stock must move past your strike price by the amount of the premium just for you to break even at expiration.
The breakeven formulas for buying premium are straightforward:
- Call Options: Strike Price + Premium Paid = Breakeven Price
- Put Options: Strike Price – Premium Paid = Breakeven Price
For example, if you buy a $150 strike call option for $5.00 ($500 total), the stock must reach $155 at expiration just for you to break even. Any price below $155 at expiration means you will lose money on the trade. That’s a 3.3% move just to get back to zero.
This is why understanding your breakeven is so critical. It forces you to honestly evaluate whether the expected move is realistic. If a stock typically moves 2% per month and your breakeven requires a 5% move in 30 days, the math simply doesn’t work in your favor.
Pro Tip
Always calculate your breakeven point before entering the trade. Then, look at the stock’s chart and historical average move. Ask yourself: “Is it realistic for the stock to reach this price within my timeframe?” If the answer is no, do not buy the option.
Using Average True Range (ATR) as a Reality Check
One practical way to evaluate your breakeven is to compare it against the stock’s Average True Range (ATR). If the stock has a 14-day ATR of $3 and your breakeven requires a $10 move, you would need more than three times the average range to profit. That’s a low-probability bet unless a major catalyst is expected.
Conversely, if your breakeven only requires a move of 1x the ATR over your holding period, the trade has a much more reasonable probability of success. This simple comparison can save you from many losing trades.
5. What is My Exit Strategy?
Perhaps the most common mistake options buyers make is entering a trade without a predefined exit strategy. Because options are leveraged instruments that decay in value, you cannot afford to “buy and hold” and hope for the best. You need a plan for every scenario.
Before you click the buy button, you must define three specific exit scenarios:
- Profit Target: At what percentage gain will you take profits? Many successful premium buyers take profits at 50% or 100% gains, rather than holding out for a home run that may never come.
- Stop-Loss: How much of the premium are you willing to lose? A common rule is to cut losses if the option loses 50% of its value. This preserves capital for the next opportunity.
- Time Stop: When will you exit the trade if the stock hasn’t moved? If you bought an option with 45 days to expiration and the stock is flat after 20 days, time decay will start accelerating. A time stop dictates that you exit to salvage remaining premium.
Having these three exits defined before you enter the trade removes emotion from the equation. When the position is live and money is on the line, your brain will try to convince you to hold losers longer and sell winners too early. Pre-defined rules prevent this.
Key Takeaway
Write down your profit target, stop-loss, and time stop before entering any premium-buying trade. Treat these as non-negotiable rules, not suggestions.
Position Sizing: The Hidden Exit Strategy
Proper position sizing is also a crucial part of your exit strategy and overall risk management. Never risk more than 1% to 2% of your total account equity on a single options purchase. If the trade goes to zero, your portfolio should easily survive.
Position sizing also determines your emotional state during the trade. If you risk too much, you will panic at every small move against you and likely exit at the worst possible time. Keep positions small enough that you can think clearly and follow your plan.
Putting It All Together: A Pre-Trade Checklist
Now that you understand the five questions, here’s how to use them as a practical checklist before every premium-buying trade. Run through each question in order. If any answer raises a red flag, either adjust your trade parameters or skip the trade entirely.
- Check IV Rank. Is it below 30%? If not, consider a different strategy.
- Select your expiration. Do you have at least 30-60 days? Is it at least 2x your expected move timeline?
- Identify your catalyst. What specific event or setup will drive the stock? When is it expected?
- Calculate your breakeven. Is the required move realistic based on the stock’s ATR and historical behavior?
- Define your exits. What’s your profit target, stop-loss, and time stop?
If you can answer all five questions with confidence, you have a well-reasoned trade. If you struggle with even one, it’s a sign that you need to do more homework or pass on the opportunity. There will always be another trade.
For more foundational knowledge on getting started with options trading, explore our comprehensive guides. And if you want to track your premium-buying trades and analyze your patterns over time, consider using OptionsPro to log and review your performance.
Frequently Asked Questions
If you still have questions about buying options premium, check out these common FAQs below. For deeper dives into any of these topics, explore our options Greeks guide.
Is it better to buy in-the-money or out-of-the-money options?
Buying in-the-money (ITM) options generally offers a higher probability of profit because they consist mostly of intrinsic value and suffer less from time decay. Out-of-the-money (OTM) options are cheaper but have a lower probability of success, as they require a larger move in the underlying stock to become profitable. Many experienced traders prefer slightly ITM or at-the-money options for a balance of cost and probability.
Why do options lose value even when the stock price doesn’t change?
Options lose value over time due to Theta decay. The extrinsic value of an option (time value) constantly erodes as the expiration date approaches. If the stock price remains flat, the option will slowly lose value every day until it expires. This is why buying premium requires the stock to move in your favor to offset the daily time decay.
What happens if I hold a bought option until expiration?
If the option expires out-of-the-money, it will expire worthless, and you will lose 100% of the premium paid. If it expires in-the-money, your broker will typically auto-exercise the option, meaning you will buy (for a call) or sell (for a put) 100 shares of the underlying stock at the strike price. Most premium buyers close their positions before expiration to avoid assignment.
How much of my portfolio should I allocate to buying options?
Most risk management guidelines suggest limiting any single options trade to 1-2% of your total account value. For your overall options allocation, many traders keep no more than 5-10% of their portfolio in speculative long options positions at any given time. The exact amount depends on your risk tolerance and experience level.
Can I still profit from buying premium if the stock moves sideways?
Generally, no. If the stock moves sideways, time decay will erode your option’s value daily. The only exception is if implied volatility increases significantly while you hold the position, which can temporarily offset time decay. However, relying on a volatility expansion without a directional move is not a reliable strategy for most traders.
