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Call option contracts give the option holder the right to buy the underlying security -- typically shares of stock -- at a set price for a fixed period of time. The cost, or premium, of a call option is partially dependent on the amount of time remaining until the option expires.

1. Call Option Function

* A call option contract is defined by several parameters. The strike price is the price of the underlying stock at which the option holder buys the stock if the option is exercised. The expiration date is the third Friday of the listed expiration month. A call option is in-the-money -- ITM -- if the stock price is above the strike price. If the stock price is below the strike price, the option is out-of-the-money -- OTM. One trader pays the option premium for the right to buy the stock at the strike price, and another trader sells the option and must deliver the stock if the contract is exercised.

Option Price Components

* The premium of a call option consists of two parts: intrinsic value and time premium. The intrinsic value is the amount the option is in-the-money and the remaining value is time value. The premium of an out-of-the-money call option is entirely time value. For example, Apple, stock symbol AAPL, is currently at $322 per share. The call option with a $310 strike price and expiration in the next month has a premium of $19. The option is $12 in-the-money and has a time premium of $7.

Increasing Time Premium

* The time premium amount of a call option is dependent on the volatility of the underlying stock and the time remaining until the option expires. Call options with a longer time until expiration will have a higher premium. For AAPL, the $310 strike price call that expires in 3 months has a premium of $27.50. This is $8.50 more time value than on the one month option. Call options with further out expirations will have higher premiums than near term options.

Time Premium Erosion

* The time value is the cost a...