Stock market index option
Encyclopedia
Stock market index option is a type of option
, which is a financial derivative
. Index options may be tied to the price of either broad-based indexes like the S&P 500 Index or the Russell 3000 Index or to narrow-based indexes, which is an index that is limited to a particular industry like the mining industry or the semiconductor industry.
The global market for exchange-traded stock market index options is notionally valued by the Bank for International Settlements
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
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
s (ETF's), the difference being that ETF's 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 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.
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
, which is a financial derivative
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
. Index options may be tied to the price of either broad-based indexes like the S&P 500 Index or the Russell 3000 Index or to narrow-based indexes, which is an index that is limited to a particular industry like the mining industry or the semiconductor industry.
The global market for exchange-traded stock market index options is notionally valued by the Bank for International Settlements
Bank for International Settlements
The Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...
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
Call option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
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
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s (ETF's), the difference being that ETF's 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 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.