Stock market index option is a type of
option
Option or Options may refer to:
Computing
*Option key, a key on Apple computer keyboards
*Option type, a polymorphic data type in programming languages
*Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
...
, a financial
derivative, that is based on
stock indices
In finance, a stock index, or stock market index, is an index that measures a stock market, or a subset of the stock market, that helps investors compare current stock price levels with past prices to calculate market performance.
Two of the ...
like the
S&P 500 or the
Dow Jones Industrial Average. They give an investor the right to buy or sell the underlying stock index for a defined time period.
Because index options are based on a large basket of stocks, investors are able 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
S&P 500 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 is notionally valued by the
Bank for International Settlements (BIS) at $368,900 million in 2005. A stock index option provides the right to trade a specific stock 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 to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy an ...
on a
stock index gives you the right to buy the index, and a put option on a stock index gives you the right to sell the index. Options on stock indexes are similar to
exchange-traded fund
An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the ...
s (ETFs), the difference being that ETF values change throughout the day whereas the value on stock index options change at the end of each trading day. Therefore, profit/loss on an index option is based on the market's closing price for the day, not on any price during the market's open hours. If an index option is exercised before the close of the market, the buyer of the option will
in- or
out-of-the-money
In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...
for an additional amount equal to the difference between the closing price and the exercise price. If the market closes above the intra-day exercise price, then the option will accrue an additional loss, and if the market closes below the intra-day exercise price, the option will accrue an additional gain. For this reason, index options are typically closed out after the market has closed.
See also
*
Derivative (finance)
In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be u ...
References
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Derivatives (finance)