A stock market index option is a type of option, a financial

derivative In mathematics, the derivative is a fundamental tool that quantifies the sensitivity to change of a function's output with respect to its input. The derivative of a function of a single variable at a chosen input value, when it exists, is t ...

, that is based on stock indices like the

S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 leading companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices and in ...

or the

Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity indice ...

. They give an investor the right to buy or sell the value of the underlying stock index for a defined time period. Because index options are based on a large basket of stocks, they allow investors to gain exposure to the market as a whole and take advantage of diversification. Index options may be tied to the price of either "broad-based indexes" like the

or the Russell 3000 or to "narrow-based indexes", which are limited to a particular industry. The global market for exchange-traded stock market index options was notionally valued by the Bank for International Settlements (BIS) at $368,900 million in 2005. A stock index option provides the right to trade an amount of cash based on the level of a specific index at a specified price by a specified expiration date. A

call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call Option (finance), option to exchange a Security (finance), security at a set price. The buyer of the call option has the righ ...

on a stock index gives the holder the right to buy the index value, and a put option on a stock index gives the holder the right to sell the index value. One difference between stock index options and index

exchange-traded fund An exchange-traded fund (ETF) is a type of investment fund that is also an exchange-traded product, i.e., it is traded on stock exchanges. ETFs own financial assets such as stocks, bonds, currencies, debts, futures contracts, and/or comm ...

s (ETFs) is that ETF values change throughout the day, whereas the intrinsic value of a stock index option is based on the index value at a certain time, usually the value at market closing time. If an index option is exercised before the close of the market, the buyer of the option will be in- or out-of-the-money for an additional amount equal to the difference between the closing price and the exercise price. For this reason, index options are typically exercised after the market has closed.

References

{{econ-stub Derivatives (finance)

See also

References