Options Quick Facts - Index Calls & Puts

What are index call options?

The buyer of an index call option has purchased the right, but not the obligation, to buy the value of the underlying index at the stated exercise price before the option expires. Once the option is purchased the buyer owns, and is then "long," the call contract. When the owner exercises an in-the-money call contract he will receive the cash settlement amount (the difference between call's strike price and the exercise settlement value of the underlying index) in cash.

Potential Profit: Unlimited as the level of the underlying index increases
Potential Loss: Limited to premium paid for call

Long Call Graph

An investor who sells an option contract that he does not already own is known as the option "writer," and is then "short" the contract. The writer of an index call option, commonly referred to as the "seller," has the obligation to sell the value of the underlying index at the stated exercise price if assigned an exercise notice before the option expires. If assigned on an in-the-money contract, the call writer will pay the cash settlement amount (the difference between call's strike price and the exercise settlement value of the underlying index) in cash to an owner who has exercised a like contract.

Potential Profit: Limited to premium received from call's initial sale
Potential Loss: Unlimited as the level of the underlying index increases

Short Call Graph

What are index put options?

The buyer of an index put option has purchased the right, but not the obligation, to sell the value of the underlying index at the stated exercise price before the option expires. Once the option is purchased the buyer owns, and is then "long," the put contract. When the owner exercises an in-the-money put contract he will receive the cash settlement amount (the difference between put's strike price and the exercise settlement value of the underlying index) in cash.

Potential Profit:Substantial and increases as the level of the underlying index decreases to zero
Potential Loss: Limited to premium paid for put

Long Put Graph

An investor who sells an option contract that he does not already own is known as the option "writer," and is then "short" the contract. The writer of an index put option, commonly referred to as the "seller," has the obligation to purchase the value of the underlying index at the stated exercise price if assigned an exercise notice before the option expires. If assigned on an in-the-money contract, the put writer will pay the cash settlement amount (the difference between put's strike price and the exercise settlement value of the underlying index) in cash to an owner who has exercised a like contract.

Potential Profit: Limited to premium received from put's initial sale
Potential Loss: Substantial and increases as the level of the underlying index decreases to zero

Short Put Graph

How can you use index options?

Consider some of the benefits of index options:

  • benefit from an up or down move in the broad market or a specific industry sector
  • protection of a portfolio of stocks from a decline in value
  • diversification for investment capital

Like equity options, index options offer the investor an opportunity to either capitalize on an expected market move or to protect holdings in the underlying instruments. The difference is that the underlying instruments are indexes. These indexes can reflect the characteristics of either the broad equity market as a whole or specific industry sectors within the marketplace.

Index options enable investors to gain exposure to the market as a whole or to specific segments of the market with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stock issues or individual equity option classes, numerous decisions and transactions would be required. Employing index options can defray both the costs and complexities of doing so

  VIX Snapshot

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