Question about index options?

Question

I’ve got a question about index options. I trade OEX and SPX contracts pretty often, but I just don’t understand this. I know it doesn’t really matter for what I do, but I was just thinking about it today.

With normal options you can actually create the contract by buying 100 shares of the stock and then writing the call. Someone sees the call, and buys it. (Simplified version)

How does it work with index options? Because they are cash based, how do the contracts get generated? Is there a set amount of contracts for each month? I understand in order for there to be a contract, there has to be the buyer and the seller. But if I’m the buyer, and you’re the seller, where did You get the contract from, and where did that person get it from before you?

Answer 1

In the case you described you put up the stock you owned to secure delivery to the option buyer. S&P index options are European style and are settled in cash at a pre-determined time in the future. Trading is done thru regular brokers, I use E*trade. When you "issue" an option, called writing you guarantee payment by setting aside and maintaining margin funds with your broker as required by the CBOE. Typically these are standard margin requirements. that is 30% of the value of the SPX which is about $124,000 and adjusted depending how far into or out of the money the strike price is.
At option expirations these near the money options can really swing and gains and losses of 40 - 50 percent can occur over 10-15 minute time frames. I've seen a $9 option peak at $21 and then quicklyy retreat to $14, then move up to $19 all in a 15 minute time span.

Answer 2

With index options, the options are usually not on the index itself, but rather on a futures contract for delivery of the cash value of the index...