Like stock options, index option prices rise or fall based on several factors, like the value of the underlying security, strike price, volatility, time until expiration, interest rates and dividends. Narrow-based indexes are based on specific sectors like semiconductors or the financial industry, and tend to be composed of relatively few stocks.
Broad-based indexes have many different industries represented by their component companies. As you would expect, however, other broad-based indexes are indeed made up of many different stocks. When stock options are exercised, the underlying stock is required to change hands. But index options are settle in cash instead. That would be ridiculous. The index value is just a gauge to determine how much the option is worth at any given time.
As of this writing, all stock options have American-style exercise, meaning they can be exercised at any point before expiration. Most index options, on the other hand, have European-style exercise. As with any other option, you can buy or sell to close your position at any time throughout the life of the contract. The last day to trade stock options is the third Friday of the month, and settlement is determined on Saturday. The last day to trade index options is usually the Thursday before the third Friday of the month, followed by determination of the settlement value on Friday.
The settlement value is then compared to the strike price of the option to see how much, if any, cash will change hands between the option buyer and seller. Stock options and narrow-based index options stop trading at 4: If a piece of news came out immediately after the stock market close, it might have a significant impact on the value of stock options and narrow-based index options. However, since there are so many different sectors in broad-based indexes, this is not so much of a concern.
All of these are very general characteristics of indexes. In practice, there are lots of small exceptions to these general rules. Although the OEX is an index, options traded on it have American-style exercise.
This table highlights a few of the general differences between index options and stock options. But make sure you do your homework before trading any index option so you know the type of settlement and the settlement date.
As you read through the plays, you probably noticed that I mentioned indexes are popular for neutral-based trades like condors. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options.
Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point.
The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.
System response and access times may vary due to market conditions, system performance, and other factors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results.
All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between. What is an Index Option? Multiple underlying stocks vs. Settlement Method When stock options are exercised, the underlying stock is required to change hands.
Settlement Style As of this writing, all stock options have American-style exercise, meaning they can be exercised at any point before expiration. Settlement Date The last day to trade stock options is the third Friday of the month, and settlement is determined on Saturday. Trading Hours Stock options and narrow-based index options stop trading at 4: Now for the disclaimer All of these are very general characteristics of indexes.
Options Guy's Tips As you read through the plays, you probably noticed that I mentioned indexes are popular for neutral-based trades like condors. Meet the Greeks What is an Index Option?More...