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Introduction to index options trading

By: Gina Alliston

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The intention of this article is to give an introduction to index options. Index options are listed on all U.S. option exchanges and are overseen by the Securities and Exchange Commission (SEC). The option exchanges supply markets for the purchase and selling of standardized options. The Options Clearing Corporation (OCC) issues, guarantees and clears all option contracts. The OCC is the exclusive clearinghouse for exchange traded options, that have in place conservative financial and technical safeguards along with significant and readily available financial assets to safeguard the corporation from settlement losses.

An index is a measure of the prices of a set of securities or other interests. There are indexes established on stocks and other equity securities, debt securities and foreign currencies, and even ones to evaluate the cost of living but, equity securities indexes, also known as stock indexes, are among the most well-known. For the purposes of this piece just the stock indexes and stock index options are discussed.

A stock index could possibly be designed to represent a specific industry for example the "steel industry", or it can represent a broad market like "industrials", it can represent the stock market of a specific country, or of securities traded in a specific market. Indexes can be structured on securities traded primarily in U.S. markets, securities traded mostly in an overseas market or a combination of securities whose chief markets are in an assortment of countries. An index could be based on the price of all or only a sample of the securities whose prices it is calculated to represent.

Options are contracts that when bought gives the buyer the right to either buy or sell the underlying instrument at a certain price for a specific period of time. The writer or seller of the option contract has the obligation to either sell or buy the underlying instrument if the buyer exercises their option.

It is imperative for traders who expect to trade index options to familiarize themselves with the method used for calculating the index, principles used in adjusting the index, and qualifications used for adding or deleting securities from the index. This info is usually accessible from the options market where the index options are traded.

Please note that while this article focuses on a general initiation of index options, it is essential to understand the features and risks of standardized options transactions prior to an investor beginning options trading. Moreover, margin requirements, transaction and commission costs and tax ramifications of buying and selling options should be discussed thoroughly with a broker and/or tax advisor prior to participating in option transactions.

Benefits of Index Options

Both equity and index options provide the investor with a chance either to generate income on an anticipated market move or to protect holdings in the underlying instruments. The underlying instruments are the tangible stock or index shares the option contracts are based on.

Index options allow investors to obtain exposure to the market as a whole or to individual segments of the market with one trading choice and often with a single transaction. While to be able to obtain the similar amount of diversification using individual stocks or individual equity options, several decisions and transactions can be required. Utilizing index options hence decreases the complexities along with the costs.

Index options offer a predetermined risk to buyers because an index option buyer absolutely can not lose more than the price of the option, referred to as the premium, unlike other investments where the risks may have no limit.

Index options can supply leverage because a buyer can pay a relatively small premium in relation to the actual cost of the underlying instrument. Which means a buyer does not have to pay the cost of the shares but can, for a smaller cost, still have a chance to capitalize on the movement of the instrument. However because of this leverage the market only has to move against the buyer a little bit to have a sizable or total loss of the buyer's premium. Conversely, writers of index options assume significantly more, if not unlimited, risk.

The OCC guarantees contract performance. Through their system OCC is capable of match trades from a buyer and a seller and operate as the link between the parties. In effect, OCC will become the buyer to the seller and the seller to the buyer. Consequently, the seller can buy back the same option he has sold, closing out the original transaction and terminating his obligation to hand over the cash equal to the exercise value of the option to OCC, and this will in no way affect the right of the original buyer to sell, hold or exercise his option.

Article Source: http://depositarticles.com/

After you have an understanding of options and stock trading basics, prior to putting your money in the stock market it's vital to acquire an options trading system

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