Essentially, stock index options are the derivatives whose underlying security isn’t a single stock. Rather, the underlying security is a basket of securities referred to as an index. As such, they provide investors with a unique opportunity to trade in options with relatively little capital and without much hassle on the broad-based market.
In this article you will learn about the most popular stock index options and other major stock indices, as well as the main features of S&P 500 and SPX index options: the most-actively traded within the U.S. stock market today.
Options on stock indices gained prominence in the ’80s after portfolio hedging became increasingly important. Since then, the CBOE (Chicago Board Options Exchange) has significantly made them more popular among brokers. What is more, the strategies used to trade index options are not that different from those used for equity options – although there are a couple of exceptions.
The underlying index for stock options can either be weighted by market capitalization or one weight by an equal dollar. The investor, to this end, has the option to trade in such broad-based indices as s&p index options or sector-specific indices that are focused on such industries as healthcare or tech.
Today, it is easy to determine the most popular stock index options depending on the specific market one is looking at. For instance, in the United States, the following are the most popular Index options:
- S&P 500 Options (abbreviated CBOE:SPX)
- Russell 2000
- CBOE Volatility Index (abbreviated CBOE:VIX)
- Nasdaq 100 (abbreviated NASDAQ:NDX)
- Dow Jones
Major Stock Indices
There are other major stock indices in the U.S. market. To better understand why these options are popular among brokers, it is essential that you review the performance of major stock groupings. These options are usually classified according to the exchange on which they trade or in terms of regions. There are other classifications investors can use to benchmark the overall and general performance of every major stock grouping.
Anyway, apart from the list given above, there are a number of other popular stock index options around the world. These include, but are not limited to:
- Amex Composite
- DWS NASDAQ-100 Volatility Target Index
- FTSE NASDAQ 500
- NASDAQ Capital Market Composite, NASDAQ Composite, NASDAQ Global Market Composite, NASDAQ Global Select Market Composite, NASDAQ OMX 100 Index, NASDAQ OMX AeA Illinois Tech Index, NASDAQ OMX Middle East North Africa Index, NASDAQ-100 Equal Weighted Index
- NYSE Composite
- OMX Baltic 10, OMX Copenhagen 20, OMX Helsinki 25, OMX Nordic 40, OMX Stockholm 30 Index
- Russell 1000, Russell 3000
- S&P MidCap
- VINX 30
- Wilshire 5000
More on S&P 500 Index Options
Coming back to the U.S. market, the S&P 500 Index is widely regarded as the leading benchmark used on the overall American stock market. As one of the most popular of the stock index options listed above, it warrants further study to improve the understanding of how it works, how it is traded, and their various advantages and disadvantages. In fact, the S&P 500 option index is considered to be the best single gauge of the largest capped U.S. equities.
There are a number of popular s&p options on the market today. These products include the SPX index options contract, which is the flagship and the most-actively traded index option within the U.S. stock market. There are also a number of contracts that feature different expirations (end-of-month and weekly), exercises (PM and AM), sizes (mini and regular) and trading methods (open outcry and electronic).
The great thing about S&P options is that thy comes with ETH (Extended Trading Hours). These trading hours for various option on the SPXW (SPX End of Month, SPX Wednesday Weeklys, and SPX End of Week Weeklys), and on the SPXPM start at 0200 HRS Central Time, and stop at 0815 HRS Central Time.
The SPX products also provide investors and brokers with different ways for efficiently gaining exposure to the U.S. stock market. These stock index options also empower traders to execute various income generation, asset allocation, hedging, and risk management strategies.
Features of the SPX Index Options
Further, it is vital that the investor understands the key features of these popular index options. These features include, but are not limited to:
a) Large Notional Size
The options have a large notional size of around $200000 for every contract on the SPX index at 2000. Not surprisingly, this is 10 times the size of SPDR options.
b) No Early Exercise
SPX options also work through European-style exercise, meaning that there are no early exercises.
c) Cash Settlement
In the same way, they are traded through cash settlements, but with no accompanying delivery of ETF or stocks.
They are also eligible for quote and price transparency with competing auction markets on all leading option contracts.
e) Mark to Market
Additionally, these stock index options fall under the daily mark-to-market options for securities regulated by the SEC.
The clearance of all transactions for trades involving the SPX options is also guaranteed. The guarantee is provided by the Options Clearing Corporation.
The rules of trade also allow for short positions in cash settled index options to be established and carried out in margin accounts to receive the covered margin treatment. This happens when the short option has been offset in one account by another equivalent position in the index-tracking ETF that was based on the same index underlying the short options.
h) Tax Treatment
Under the Tax Code, section 1256, loss and profit on transactions involving certain exchange-traded stock index options – such as the SPXpm and the SPX – are entitled to taxation at rates equal to 40% short term and 60% long term capital loss or gain. This is under the provision that the strategy employed and the investor involved have satisfied the criteria outlined by the Tax Code.
In conclusion, understanding how each of the most popular stock index options is traded will go a long way in improving your knowledge of these trades, as well as the unique advantages and disadvantages each offers. Keep in mind the different features each individual option offers such as notional size, transparency and margins and learn to use them to gain an advantage.
Over and above all, stock index options are popular because they allow for diversification and liquidity. They are also less volatile, come with predetermined risk/loss, provide leverage, are relatively low cost, and they are cash settled.
To better understand index option return, try reading this PersonalIncome.org guide.
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