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Many experienced stock option investors are involved with index options. These contracts allow trading of calls and puts, but give them an advantage when looking to profit on the market - as a whole or on a specific sector.
When a single stock call option contract is bought, the trader is relying on that particular security or company to rise - so the call becomes more valuable. However, what if the dow jones or the S&P rose 5% in a week, but your stock or option did not?
If a person feels the market on a particular stock will go up, then a call contract on that one company makes sense. But, if the feeling is more towards a general or overall increase in the market, then an index option that is broad based would be the better investment choice.
If the trader felt that a specific sector of the market were going to rise - perhaps small cap energy stocks, for instance. Then, finding and buying a narrow based index option in that specific sector would be the best choice.
Trading
Index Options are normally traded for premium to close out the positions. They are not normally exercised. Index contracts exercise and settle in cash. No delivery of actual securities is done. Given that fact, stock traders tend to just buy, sell, or cover them for premium gain.
If the trading of the contract is not done, then they will expire or get exercised on the expiration date. All contracts are settled on that date. This includes paying investors the "in the money" amount or the intrinsic value of the option.
Premium
Since all option contracts and markets rely on price movement for the investors and trading public to make money, Index contract premiums are normally high. An index will normally have bigger price movements than an individual stock or stock option. When a particluar sector of the market is in a bullish phase, that sector's stocks and call options will perform well. Buying an index contract prior to or during an upswing in that industry can create a great money making opportunity, even with the high premiums on the option.
Intrinsic Value Option Formula
The Index Trading Course (Wiley Trading)
Option Strategies: Profit-Making Techniques for Stock, Stock Index, and Commodity Options, 2nd Edition
Copyright  2006 American Investment Training, Inc.
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