What actually drives option prices up or down?

In the last article, we learned that an option’s price equals its intrinsic value + time value.

But that raises the next big question:
What actually drives option prices up or down?

The good news — it’s not rocket science.
In fact, it’s a lot like how your car insurance premium is calculated.
There are three main factors:

1. The value of the asset you’re insuring

2. How long the coverage lasts

3. How risky that asset is

Let’s break each one down.

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① The Price of the Underlying Asset

(Why a Ferrari Costs More to Insure Than a Toyota)

Imagine you’re getting insurance for two cars — a used Toyota and a Ferrari.
Which one do you think costs more to insure?
Easy: the Ferrari. The more valuable the car, the higher the insurance premium.

The same logic applies to options:
When the underlying asset’s price rises, call options (which bet on price increases) become more valuable, while put options (which bet on price drops) lose value.

Real-Life Example:

Back in August 2020, the SPY ETF (which tracks the S&P 500) jumped roughly 8% in a week.
During that surge:

• Call options on SPY for the following month soared, some up more than 60%.

• Meanwhile, equivalent put options collapsed, dropping over 60% in value.

👉 In short, when the underlying asset moves, options follow — call options cheer when prices rise, put options celebrate when prices fall.

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② Time: The “One-Year vs. Three-Year” Insurance Policy

Now think about your car insurance again.
If you buy a three-year policy, it’ll cost more than a one-year one.
Why? Because the longer the time frame, the more uncertainty — and the more risk the insurer has to cover.

Options behave exactly the same way.
A contract that expires in six months usually costs more than one that expires next week, even if they’re for the same strike price.

Example:

Suppose SPY’s price doesn’t move much for a week — say, from $261.10 to $260.40.
Even though the ETF stayed flat and market volatility didn’t change,
a one-month call option still dropped about 12% in price.

Why? Because every day that passes, part of its time value naturally decays — a process traders call “time decay” or theta decay.

👉 The closer the option gets to expiration, the less time it has for things to go its way — and the cheaper it becomes.

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③ Volatility: The Risk of an “Accident”

Finally, let’s talk about volatility, the financial equivalent of your car’s accident history.

If your Ferrari got into a wreck last year, guess what happens to your next insurance quote?
It jumps.
That’s because insurers see you as riskier.

In options, volatility is how the market measures risk.
The more unpredictable the asset’s future price, the more traders are willing to pay for options — because those options have a higher chance of becoming profitable.

• Higher volatility = pricier options (more uncertainty, more potential).

• Lower volatility = cheaper options (calm markets, fewer surprises).

Example:

On November 23, 2020, SPY ticked up just 0.6% — barely moving.
Yet strangely, both calls and puts fell in price.

Why? Because implied volatility — traders’ expectations of future price swings — dropped sharply:

• Call options’ implied volatility slid from 25% to 20%.

• Put options’ implied volatility dropped from 35% to 30%.

Even without big price moves, lower volatility expectations reduced the “risk premium” baked into option prices.

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The Bottom Line

Options don’t move randomly — they’re driven by three clear forces:

1. Underlying Price: When the stock or ETF rises, calls go up and puts go down — and vice versa.

2. Time to Expiration: The closer the option is to expiration, the less it’s worth.

3. Volatility: The more uncertain the market, the pricier the options.

👉 In one sentence:
An option’s price works just like your car insurance — it depends on the value of what you’re insuring, how long the coverage lasts, and how risky the road ahead looks.

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