Author Topic: Index Option  (Read 256 times)

Offline Md. Al-Amin

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Index Option
« on: February 24, 2014, 11:26:07 AM »
Index Option

Introduced in 1981, index options are call or put options on a financial index comprising many stocks.

How it works/Example:

Index options usually have a contract multiplier of $100, meaning that the price of an index option equals the quoted premium times $100. Unlike options in shares of stock or even commodities, it's not possible to physically deliver the underlying index to the purchaser of an index option. Thus, index options settle via cash payments.

Many times it is in an investor's best interest to lock in recent gains or to protect a portfolio of stocks from a decline beyond a certain price. One way to do this would be to purchase a put option contract on each of your various holdings (this would essentially allow you to "lock in" a particular sale price on each stock, so even if the market crashed, your overall portfolio wouldn't suffer much). However, if you hold a large, diversified portfolio of stocks, then it is probably not cost-effective to insure each and every position in this manner.

As an alternative, investors might want to consider using index options to hedge the risk in their portfolios. Many different indices have options available, including the Nasdaq 100, the Dow Jones Industrial Average and the S&P 500. With some careful planning, investors should be able to offset a sharp decline in a portfolio by hedge their overall position with index options. Though it is impossible to forecast exactly how a portfolio will perform during a steep market sell-off, one can get fairly close to the actual result by determining which particular index to use as a proxy for the portfolio and then determining the correct number of options to use as a portfolio hedge.

Why it Matters:

Index options are essentially bets on the overall movement of the market or a basket of stocks. Hedgers and speculators can use them to get exposure to an entire market or entire sector in a single, quick transaction. And like other options, index options offer leverage and predetermined risk. After all, the most the index option trader can lose is the premium he or she paid to hold the options, and the upside can be incredible.

It is important to note that equity index options have special tax consequences: 60% of any gain on the sale of the option is taxed as a long-term capital gain; the other 40% is taxes as short-term capital gain income.

http://www.investinganswers.com/financial-dictionary/options-derivatives/index-option-4802

Offline munna99185

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Re: Index Option
« Reply #1 on: March 09, 2014, 03:10:49 PM »
An index option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell a basket of stocks, such as the S&P 500, at an agreed-upon price and before a certain date. An index option is similar to other options contracts, the difference being the underlying instruments are indexes. Options contracts, including index options, allow investors to profit from an expected market move or to reduce the risk of holding the underlying instrument. Index options provide diversification as investors are exposed to a large number of securities in one trading instrument. The degree of exposure varies with the particular index option. Popular index options include S&P 500 Index Options (SPX), Dow Jones Industrial Average Index Options (DJX) and Nasdaq-100 Index Options (NDX). Index options are typically cash settled. [Source: http://www.investopedia.com]

Sayed Farrukh Ahmed
Assistant Professor
Faculty of Business & Economics
Daffodil International University