Trading a Sector Option
Index options trade and can be exercised and assigned similarly to
listed equity options; however, unlike equity options, they settle in
cash, not stock. The assigned writer (seller) is obligated to pay the
exercising holder (buyer) the difference between the closing value of
the underlying index and the exercise price of the option, multiplied
by the specified index multiplier (typically $100). Simply stated, the
multiplier is the unit of trading for a sector option. A multiplier of
100 means that for every point a sector option is in-the-money, there
is an incremental $100 of intrinsic value in the option.
Exercise Style
Sector options have either an American or European exercise style. An American-style option can be exercised at any time through the last day of trading prior to expiration. A European-style option prohibits exercise until the last business day before expiration. Whether a sector option is American- or European-style, the option can always be bought or sold prior to expiration.
Exercise Settlement Values
For some index options, the exercise settlement value is based on the closing prices of the component stocks on the last business day prior to expiration (usually a Friday). Others cease trading at the close two business days prior to expiration (usually a Thursday) as the settlement value is based on Friday?s opening prices of the component stocks. No matter which way the exercise settlement value is determined, expiration of contracts occurs on the Saturday following the third Friday of the month. Cash, not stock, is delivered upon settlement; therefore, it is important that buyers and sellers of sector options realize that exercising an option terminates their position in the market. It is also important that investors consider the exercise and settlement features of sector options when devising a trading strategy.
FLEX Options
FLexible EXchange Options (FLEX Options) may also be available
for some index options. FLEX Options allow users to customize
their contract terms to meet specific hedging and investment needs.
Investors can specify the expiration date, strike price, exercise style
(American or European), and choice of either a.m. settlement
(reported at the opening of trading) or p.m. settlement (reported at
the close of trading). Contact any exchange or your broker to receive
more detailed information about FLEX Options.
Sectors enable an investor to participate in market moves without
having to select a specific stock or group of stocks. They offer profit
potential and allow investors the ability to control their exposure to
market risk. Converting market insight into specific investments or trading action can be time-consuming and fraught with frustration. Deciding which stocks to purchase is a common dilemma. Sectors can provide a simpler, more efficient, and less costly means of trading. These contracts allow an investor to focus on market movement without the risk of having to be correct about a particular stock.
Sectors give traders and investors a means to adjust their positions
easily and quickly in response to market changes. An inherent risk in
any securities position is that an overall market decline may send its
price downward while an overall market increase may not advance its
price upward. A defense against these risks is a sector index option.
Investors can rely upon sector options to hedge diversified or industry
specific portfolios during periods of market uncertainty, and to reduce
risk exposure while maintaining their specific market commitment.
In summary, sector index options are used to facilitate actions based
on market opinion and strategy, to enhance the potential rewards of
astute judgement, or to hedge a portfolio. Anyone holding a group of
stocks, whether an individual investor, a trust department, or a
portfolio/fund manager, may benefit from sector index options.
Frank Kneipher
FKPRINTS1@YAHOO.COM
