What's the Difference Between an Index Option and an Equity Option?
An option is a contract to buy or sell a specific financial product officially known as the underlying instrument or underlying interest. With an index option, the underlying interest is a market index. In an equity option, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product.
Contracts for Index and Equity Options
The contract for these options is very precise. This contract establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. It has an expiration date, and once it expires, the option no longer has any value and no longer exists. The seller of an option is then obliged to sell (in the case of a call) or buy (in case of a put) the shares to (or from) the buyer of the option at a specific price, upon the buyer’s demand.
Types of Options
Options come in two varieties: calls and puts, and you can buy or sell either type. You make those choices – whether to buy or sell and whether to choose a call or a put – based on what you want to achieve as an options investor. Strike prices (exercise prices) are the quoted price per share for which the option holder purchases (in the case of a call) or sells (in the case of a put) upon exercise of the option contract. The strike price is not the same as the premium. A premium is the price at which the contract trades, which fluctuates daily. The strike price is a fixed specification of an option contract.
The Basics of Equity Options
Equity options are securities that give the holder the right to buy (called a call) or sell (called a put) a specified number of shares of stock, at a specified price for a certain (limited) period. After this date, the option ceases to exist. Typically, one option equals 100 shares of stock.
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The Basics of Index Options
Index options offer the investor a chance either to benefit from an expected market move or to protect holdings in the primary instruments. The difference here is that the underlying instruments are indexes. 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 operation. Unlike other financial investments, index options offer a known risk to investors. An index option buyer cannot lose more than the price of the option, the premium. Index options can provide leverage. An index option buyer can pay a small premium for a market exposure in relation to the contract value.
To learn more about index options and equity options, visit the Options Industry Council or the International Securities Exchange.
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