S&P 400 index options are option contracts in which the underlying value is based on the level of the S&P 400, a capitalization weighted index that measures the performance of the mid-range sector of the U.S. stock market. The index components consist of 400 mid-cap stocks chosen on the basis of market capitalization, liquidity and industry group representation.
The S&P MidCap 400 index option contract has an underlying value that is equal to the full value of the level of the S&P 400 index. The S&P MidCap 400 index option trades under the symbol of MID and has a contract multiplier of $100.The MID index option is an european style option and may only be exercised on the last business day before expiration.
|Product Name||Symbol||Underlying Value||Contract Multiplier||Exercise Style|
|S&P MidCap 400 Options||MID||Full Value of S&P 400||$100 |
(Full Contract Specs)
If you are bullish on the S&P 400, you can profit from a rise in its value by buying S&P MidCap 400 (MID) call options. On the other hand, if you believe that the S&P 400 index is poised to fall, then MID put options should be purchased instead.
The following example depict a scenario where you buy a near-money MID call option in anticipation of a rise in the level of the S&P 400 index. Note that for simplicity's sake, transaction costs have not been included in the calculations.
You observed that the current level of the S&P 400 index is 498.83. The MID is based on the full value of the underlying S&P 400 index and therefore trades at 498.83. A near-month MID call option with a nearby strike price of 500 is being priced at $33.26. With a contract multiplier of $100.00, the premium you need to pay to own the call option is thus $3,326.00.
Assuming that by option expiration day, the level of the underlying S&P 400 index has risen by 15% to 573.65 and correspondingly, the MID is now trading at 573.65 since it is based on the full value of the underlying S&P 400 index. With the MID now significantly higher than the option strike price, your call option is now in the money. By exercising your call option, you will receive a cash settlement amount that is computed using the following formula:
Cash Settlement Amount = (Difference between Index Settlement Value and the Strike Price) x Contract Multiplier
So you will receive (573.65 - 500.00) x $100 = $7,365.45 from the option exercise. Deducting the initial premium of $3,326.00 you paid to buy the call option, your net profit from the long call strategy will come to $4,039.45.
|Profit on Long MID 500 Call Option When S&P 400 at 573.65|
|Proceeds from Option Exercise||=||Cash Settlement Amount|
|=||(Index Settlement Value - Option Strike Price) x Contract Size|
|=||(573.65 - 500.00) x $100|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Proceeds from Option Exercise - Investment|
|=||$7,365.45 - $3,326.00|
|Return on Investment||=||Net Profit / Investment|
In practice, it is usually not necessary to exercise the index call option to take profit. You can close out the position by selling the MID call option in the options market. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.
In the example above, as the option sale is performed on expiration day, there is virtually no time value left. The amount you will receive from the MID option sale will still be equal to it's intrinsic value.
One notable advantage of the long S&P MidCap 400 call strategy is that the maximum possible loss is limited and is equal to the amount paid to purchase the MID call option.
Suppose the S&P 400 index had dropped by 15% instead, pushing the MID down to 424.01, which is way below the option strike price of 500. Now, in this scenario, it would not make any sense at all to exercise the call option as it will result in additional loss. Fortunately, you are holding an option contract, and not a futures contract, and so you are not obliged to anyway. You can just let the option expire worthless and your total loss will simply be the call option premium of $3,326.00.
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