Index Option Trading

Introduced in 1981, stock index options are options whose underlying is not a single stock but an index comprising many stocks. Investors and speculators trade index options to gain exposure to the entire market or specific segments of the market with a single trading decision and often thru one transaction. Obtaining the same level of diversification using individual stocks or individual stock options require numerous transactions and consequently slower decision making and higher costs.

Leverage & Predetermined Risk for the Buyer

Like equity options, trading index options gives the investor leverage and predetermined risk. The index option buyer gains leverage as the premium paid relative to the contract value is small. Consequently, for a small percentage moves of the underlying index, the index option holder can see large percentage gains for his position. Furthermore, risk is predetermined as the most the index option trader can lose is the premium paid to hold the options. 

Contract Multiplier

Stock index options typically have a contract multiplier of $100. The contract multiplier is used to compute the cash value of each index option contract.

Premium

Similar to equity options, index options premiums are quoted in dollars and cents. The price of a single equity index option contract can be determined by multiplying the quoted premium amount by the contract multiplier. This is the amount that an index option buyer will need to pay to purchase the option and the amount that the index option writer will receive when selling the option.

Rights Conferred

As index options are cash-settled options, the holder of an index option does not possess the right to purchase or sell the underlying stocks of the index but rather, he or she is entitled to demand the equivalent cash value from the option writer upon exercising his option.

Ready to start trading? Open an account at OptionsHouse.com and get 100 commission-free trades + free virtual trading tool!

Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.

Once you start trading for real, your first 100 trades will be commission-free! (Make sure you click thru the link below and quote the promo code 'FREE100' during sign-up)

Click here to open a trading account at OptionsHouse.com now!

Bookmark and Share
Browse Glossary: A B C D E F G H I J K L M N O P Q R S T U V W X Y Z