An index option is an option whose underlying security is an index. For example, instead of buying an option contract based on the performance of a particular stock, you could buy an option contract based on the performance of, say, the S&P 500.
Most index options are cash-settled. Cash-settled means that there is no transfer of physical shares upon exercise or assignment, only cash.While a stock option contract can result in the sale or purchase of shares of the underlying stock, there is no tangible asset in the case of an index option, so index option contracts traded on the Chicago Board Options Exchange (CBOE) are usually settled with cash.
The cash delivery amount upon expiration for an in-the-money index option is equal to the difference between the settlement value and the strike price, times a multiplier of 100. Long option holders receive this amount, while short sellers are obligated to deliver the same amount.
For example, you buy a call option contract on Index XYZ with a strike price of $1,100. At the contract expiration, Index XYZ is at $1,125. Your net gain would be ($1,125 - $1,100) x 100 = $2,500. To determine your actual profit from the transaction, subtract the premium you paid to purchase the contract.
Contract: Call Index XYZ
Strike Price: $1,100
Price at Expiration: $1,125
Net Gain: $2,500
Profit: $2,500 - contract premium
Like other options contracts, index options have characteristics that will differ depending on the particular index. Those characteristics include:
- American style options or European style options
- a.m. or p.m. settlement
Broad-based (spans a wide range of stocks) or narrow-based (limited to one particular sector)
Because the characteristics of index options can vary from one index to the next, researching the individual specifications of an index option contract is recommended prior to engaging in trading.The Chicago Board Options Exchange provides investors with information useful for determining the underlying symbols, as well as the characteristics of a particular index option you may be interested in trading.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in the Scottrade Options Application and Agreement, Brokerage Account Agreement, and by downloading the Characteristics and Risks of Standardized Options and Supplements (PDF) from The Options Clearing Corporation, or by requesting a copy from your local branch office. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.