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Ask the Institute

DATE: February 24, 2014

QUESTION:

Can you explain the difference between an equity-settled option and a cash-settled option?

ANSWER:
In regard to an equity-settled option, shares of the underlying stock or exchange-traded fund are bought and sold. The exerciser of an equity-settled call buys shares at the strike price of the call, and the exerciser of an equity-settled put sells shares at the strike price of the put. On the other side of an exerciser of an equity-settled option is the assigned option writer who must fulfill the obligation. In the case of an assigned call, shares are sold at the strike price, and in the case of an assigned put, shares are bought at the strike price. In the United States, all options on individual stocks and on exchange-traded funds are equity-settled options.

In contrast, a cash-settled option is settled as its name implies, in cash. The exerciser of a cash-settled call receives the in-the-money dollar value of the call in cash, and the exerciser of a cash-settled put also receives the in-the-money dollar value of the put in cash. On the other side of an exerciser of a cash-settled option is the assigned option writer who pays the in-the-money dollar value in cash. In the United States, all options on indexes such as the S&P 500® Stock Index, or the Dow Jones Industrial Average?, and many other broad-based and narrow-based indexes are cash-settled options. To learn more about equity-settled options and cash-settled options, view this segment of "Ask the Institute."


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