The Stock Index Options are options where the underlying asset is a Stock Index e.g. Options on 'Sensex'. Index Options were first introduced by Chicago Board of Options Exchange (CBOE) in 1983 on its Index 'S&P 100'. As opposed to options on Individual stocks, index options give an investor the right to buy or sell the value of an index which represents a group of stocks.
What are the uses of Index Options?
Index options enable investors to gain exposure to a broad market, with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stocks or individual equity options, numerous decisions and trades would be necessary. Since broad exposure can be gained with one trade, transaction cost is also reduced by using Index Options. As a percentage of the underlying value, premiums of Index options are usually lower than those of equity options as equity options are more volatile than the Index.
Who would use Index Options?
Index Options are effective enough to appeal to a broad spectrum of users, from conservative investors to more aggressive stock market traders. Individual investors might wish to capitalize on market opinions (bullish, bearish or neutral) by acting on their views of the broad market or one of its many sectors. The more sophisticated market professionals might find the variety of index option contracts excellent tools for enhancing market timing decisions and adjusting asset mixes for asset allocation. To a market professional, managing the risk associated with large equity positions may mean using index options to either reduce their risk or to increase market exposure.
What are Options on Individual Stocks?
Options contracts where the underlying asset is an equity stock are termed as Options on Individual Stocks. They are mostly American style options, cash settled or settled by physical delivery. Prices are normally quoted in terms of the premium per share, although each contract is invariably for a larger number of shares, e.g. 100.
Which are the stocks on which options are available?
Stocks are selected on the basis of their satisfying various eligibility and selection criteria. The various stocks available for trading on the derivatives segment can be viewed on the respective sites of BSE and NSE.
How will introduction of options in specific stocks benefit an investor?
Using various combinations of calls and puts, investors can use options effectively for creating hedging or speculative positions in line with their tolerance of risk. Investors of equity stock options will enjoy more leverage than their counterparts who invest in the underlying stock market itself in form of greater exposure by paying a small amount as premium. Investors can also use options in specific stocks to hedge their holding positions in the underlying (i.e. long in the stock itself), by buying a Protective Put. Thus they will insure their portfolio of equity stocks by paying premium. ESOPs (Employees' stock options) have become a popular compensation tool with more and more companies offering the same to their employees.
