Options are available on more than 50 stock indexes, including the S&P 500® (SPXTM ), S&P 100® (OEX® and XEOSM), Dow Jones Industrial AverageSM (DJX), Russell 2000® (RUT), and Nasdaq-100 (NDX).

More than one billion stock index options have been traded since the CBOE launched the first cash-settled securities product - OEX index options - in 1983.

Some of the key features of index options are listed below and also are covered throughout this Index Workbench.

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.

Predetermined Risk for Buyer

Unlike other investments where the risks may have no limit, index options offer a known risk to buyers. An index option buyer cannot lose more on the purchase of options than the price of the option, the premium.

Leverage

Index options can provide leverage. This means an index option buyer can pay a relatively small premium for market exposure in relation to the contract value. An investor can see large percentage gains from relatively small, favorable percentage moves in the underlying index. If the index does not move as anticipated, the buyer's risk is limited to the premium paid. However, because of this leverage, a small adverse move in the market can result in a substantial or complete loss of the buyer's premium. Writers of index options can bear substantially greater, if not unlimited, risk.

Guaranteed Contract Performance

An option holder is able to look to the system created by Rules and Bylaws of the Options Clearing Corporation ("OCC") (which system includes the brokers and Clearing Members involved in a particular option transaction) and to certain funds held by OCC rather than to any particular option writer for performance. Prior to the existence of option exchanges and OCC, an option holder who wanted to exercise an option depended on the ethical and financial integrity of the writer or his brokerage firm for performance. Furthermore, there was no convenient means of closing out one's position prior to the expiration of the contract. OCC, as the common clearing entity for all exchange-traded option transactions, resolves these difficulties. Once OCC is satisfied that there are matching orders from a buyer and a seller, it severs the link between the parties. In effect, OCC becomes the buyer to the seller and the seller to the buyer. As a result, the seller can buy back the same option he has written, closing out the initial transaction and terminating his obligation to deliver cash equal to the exercise amount of the option to OCC. This will in no way affect the right of the original buyer to sell, hold or exercise his option. All premium and settlement payments are made to and paid by OCC. The OCC has received a triple-A credit rating from Standard & Poor's Corporation.

Cash Settlement

A key difference between equity and index options is in the method of settlement. Generally, when an index option is exercised by its holder, and when an index option writer is assigned, cash changes hands. Only a representative amount of cash changes hands from the investor who is assigned on a written contract to the investor who exercises his purchased contract. This is known as cash settlement.

For a pamphlet on "Understanding Index Options," please click here.