# Where the Premium Comes From

> The volatility risk premium exists because of who buys options and why, and because of what the sellers who meet that demand charge for the risk.

Canonical: https://spout.finance/docs/where-the-premium-comes-from/

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The volatility risk premium exists because of who buys options and why, and because of what the sellers who meet that demand charge for the risk.

- **Pension funds and asset managers buy protection.** They hedge large portfolios because their mandates require it, often paying whatever the market asks. For them, protection matters more than whether the price is fair.
- **Retail traders buy calls as lottery tickets.** Out of the money calls on popular stocks are bought for the chance of a large payoff. In aggregate, these buyers pay more than the options turn out to be worth.

- **Dealers charge for carrying risk.** Market makers who sell these options must hedge them and are exposed to sudden moves, so they price options above what expected moves alone would justify.

All three push option prices above what stocks' actual moves justify. Institutional desks and volatility funds have collected this premium for decades.

## Why Spout can offer it to lenders

For a fund, running covered calls means owning the stock and taking all of its downside to earn a small premium. Spout splits the trade between two people who each want one half:

|  | Takes | Gets |
| --- | --- | --- |
| Borrower | The stock's price risk, which they already wanted | A 0% loan |
| Lender | Dollar exposure. Junior absorbs losses before Senior, and the Insurance Fund stands in front of lenders for bad debt | The premium |

The premium has always existed in the market, and it has mostly gone to institutions. What was missing was a way to deliver it to the people who supply the stock and the dollars, without making a lender own the stock.