Getting Started with Index Options
Maybe you've been trading stocks or stock options for a while and are looking for new opportunities.
Have you considered index options? They're not just for institutional investors anymore.
In fact, many retail equity options traders can make an easy transition to Mini S&P 500 and Mini Russell 2000 Index options. That's because they are smaller versions of the equivalent standard index options contracts. At 1/10th the size of the standard contracts, Mini Index options allow retail traders to gain broad market exposure and execute trading strategies with less capital.
5 Reasons to Trade Index Options
Index options can help traders diversify a portfolio and gain broad exposure with (in most cases) one trade. As compared to single stocks, index options reduce the probability of experiencing a gap move and help narrow the focus to market risk instead of individual company risks.
Index options tend to have lower volatility than options on individual stocks. Volatility around earnings reports, mergers, and other news events can have a significant impact on stock options prices. But with index options, those volatile moves tend to smooth out.
Index options are European style, meaning they cannot be exercised before expiration. Equity options, on the other hand, can be exercised anytime. Stock options settle to shares of the underlying stock, while index options settle to cash.
Index options typically qualify for the 60% long-term, 40% short-term capital gains tax treatment.*
Index options often have narrower bid/ask spreads than single-stock options due to greater liquidity.
Stocks, Stock Options, and Index Options
|Stocks||Stock Options||Index Options|
|Diversification||Access shares of specific companies||Access derivatives on shares of specific companies||Access a basket of stocks that represent a broad market or sector|
|Settlement method||Shares of companies||Shares of underlying stock||Cash|
|Exercise style||N/A||American style (settle anytime)||Mostly European style (settle only at expiration)|
|Tax Treatment||Standard capital gains tax treatment||Standard capital gains tax treatment||60% long term, 40% short-term capital gains*|
*Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options and futures are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option or futures strategy will be taxed and should be reported for tax purposes. Tax laws and regulations change from time to time and may be subject to varying interpretations. No representation is made regarding tax consequences or tax reporting requirements.
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of "Characteristics and Risks of Standardized Options." Copies are available from your broker or from The Options Clearing Corporation at 125 S. Franklin Street, Suite 1200, Chicago, IL 60606 or at www.theocc.com.
Past performance is not indicative of future results. The information in this article is provided for general education and information purposes only. No statement(s) within this article should be construed as a recommendation to buy or sell a security or future or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in this article is available by contacting Cboe Global Markets at cboe.com/contact.