Wednesday, 14 September 2016

HOW TO TRADE IN INDEX OPTIONS

An index option is the same as equity or stock option, except the underlying asset is an index instead of a stock. Just like an equity call option, an index call option is the right to buy the underlying index. And just like equity put option, an index put option is the right to sell the underlying index.
In other words, an index option is a security that allows the owner to buy or sell an index at a specified price by a specified date. It is an "option" because the owner does not "have to" exercise the option, but rather decides based on the price of the underlying if they want to exercise it. Index options are defined by the following 4 characteristics:
  • There is an underlying index
  • There is an expiration date of the option
  • There is a strike price of the option
  • The option is either the right to buy or the right to sell (call and put, respectively)
The difference between calls and puts is the owner of an index call option has the right to BUY an index at a certain price. The owner of a put option has the right to SELL an index at a certain price.
They are called index options because when you own index options you have a choice as to whether or not you want to exercise them and take position of the underlying security. For example, when you have a call option you have the choice to buy the index at that certain price by the expiration date (obviously if the current market price of the index is less than the strike price, then you would not exercise the call option and you would not buy the underlying).
Likewise, when you have a put option you have the choice to sell it at the strike price by the expiration date (obviously if the current market price of the index is higher than the strike price of the put, then you would not exercise the it since it is not logical for you to sell the index at the lower price when you could sell it for more on the open market). For call and put options, if you choose to buy the index (or sell it if you have a put), it is called "exercising" the options. If you choose not to exercise the option, the options are said to have "expired."


No comments:

Post a Comment