INDEX OPTIONS instead of stock options?

Question

Can someone explain HOW index options settle (in cash) as opposed to stock options? Thanks

Answer 1

"Just as stock options are defined as contracts that give the buyer the right to buy or sell a stock at a stated price for a limited period of time, cash-settled index options give buyers similar rights. However, the underlying asset covered by index options is not shares in a company, but rather, an underlying dollar value equal to the index level multiplied by $100. The amount of cash received upon exercise or at expiration depends on the settlement value of the index in comparison to the strike price of the index option."

For example, if you owned a VIX call with a strike of $15, and the settlement value of VIX at expiration was $18.00, you would be paid $300 for the call at expiration.

Before trading any index option I recommend you check the specifications for the options on that index at

http://www.cboe.com/Products/Cash-SettledIndexOptions.aspx

You may also want to read the brochure "Understanding Index Options" from

http://www.cboe.com/LearnCenter/pdf/understandingindexoptions.pdf

Three places where I suggest care is needed:

Some index options have American-style settlement while others have European-style.

Expiration is not always following the third Friday of the month.

Determination of the settlement value is not always as straight-forward as you might expect.

Answer 2

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