Cash settled or cash-based options are option contracts whereby settlement is done via the payment of cash equal to the difference between the market value and the contractual value of the underlier at the time of exercise or expiration. This is opposed to physically settled options in which actual physical delivery of the underlying security is required.
Cash settlement is performed when delivery of the underlier is inconvenient, costly or simply not possible.
For example, the S&P 500 index option is cash settled because not only would physical delivery be inconvenient, the transaction costs incurred to deliver all 500 component stocks that make up the index would be too high.
Similarly, CBOE Volatility Index® (VIX®) options are also cash settled as physical delivery is impossible since the underlying is not an asset but merely a statistic.
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