Overview
This lecture explains index options, compares them to standard equity options, and highlights their key features, settlement styles, and expiration differences.
What Are Index Options?
- Index options are options contracts where the underlying asset is a market index, not individual company shares.
- Indexes like the S&P 500 measure the performance or value of groups of assets, such as top 500 US companies.
- You cannot trade shares of an index directly, but you can trade options based on them.
Trading and Liquidity of Index Options
- Index options offer multiple expiration cycles and are heavily traded, providing good liquidity.
- Bid-ask spreads for popular index options are tight, even for high-value indexes.
- Strategies used in equity options (buy/sell calls or puts, spreads, etc.) also apply to index options.
Key Differences Between Index Options and Equity Options
- Index options are cash settled; no shares are exchanged at expiration or exercise.
- Profits or losses are paid in cash based on the difference between strike price and index value.
- Index options are European-style, meaning they can only be exercised at expiration, not before.
- Most equity options are American-style and can be exercised at any time before expiration.
Expiration Features of Index Options
- Index option expirations can occur at non-standard times and dates (e.g., morning instead of afternoon, or on Wednesdays instead of Fridays).
- Equity option expirations typically occur on Friday afternoons (third Friday for monthly contracts).
- Always check the specific expiration details (date and time) for each index option contract.
Key Terms & Definitions
- Index — A measurement tool showing the performance or value of a group of assets.
- Index Option — An options contract with a market index as the underlying asset.
- Cash Settled — Settlement method where contracts are resolved with cash, not an exchange of underlying securities.
- European-Style Option — Can only be exercised at expiration.
- American-Style Option — Can be exercised at any time before expiration.
- Liquidity — How easily an asset or contract can be bought or sold without affecting its price.
- Bid-Ask Spread — The difference between the highest price a buyer will pay and the lowest price a seller will accept.
Action Items / Next Steps
- Review actual expiration dates and times when trading index options.
- Consider taking in-depth courses on options trading and investing if further study is needed.