Trade Options

Index options are those options where the underlying asset under trading is an index. Since physical delivery is not possible in case of index options, the index options are settled by cash payment. Just as in equity options, where the underlying securities are equities, the index options provide the traders the opportunity to capitalize on the expected market move or protect the holdings in the indexes.

We are aware that options are contracts that allow the trader to purchase the right to buy options to buy or sell the underlying security for a set period of time and at a specific price. Therefore, in simple words, the index options are contracts where the trader has the option to trade against the specific index’s price changes in place of the specific stocks.

Those that trade index options are aware of the fact that these options lets the traders profit from the trends of the market as a whole and are not affected by the changes in a particular stock. The settlement of the contract is always in cash, as there cannot be any delivery like the equities.

Advantages of trading index options

1. Diversification: since index options traders have the complete exposure to the price changes of the market as a whole or to particular segments, they obtain a level of diversification, which is not possible with individual stocks or individual equity options. The same level of diversification in individual stocks would involve complex calculations and costs.

2. Leverage: due to the concept of options, traders can enter the index options trading arena by paying a small amount of premium, which is negligible when compared to the value of the contract. Thus even with small initial investment traders can seek favorable gains when the underlying index moves in the favored direction. If however, the index does not move in the anticipated direction, the risk for the buyer is limited to the amount spent on the purchase of the option that is the premium amount.

3. Predetermined risk: Unlike other instruments of trading, the index options provide the buyer a known risk. Therefore, he cannot lose more than the premium amount, so he is aware of his maximum potential loss.

How to trade index options

1. Simply select the index on which you intend to trade options. The current price trends can be reviewed from the price charts.

2. On the online broker account screen, enter the index’s symbol. The “option chain” displays the options that are present for the index.

3. Select the “near the money” option and the expiration date from next month or the month after. The “call” option is bought when the anticipation is for the index to rise. If you believe that the index would fall, buy the “put” option.

4. Click on the button marked trade, when the option to be traded is selected.

5. Put in the number of contracts that you wish to trade in and midway between the bid and the ask price, set the limit price and place the order.

6. Keep vigil over the status order and review the value of the index if it is not filled in five minutes. You can adjust the limit price.

7. To close the position in case your anticipation of the valuation of the index is wrong, set a stop loss order.

8. When the projected index value is breached, simply take the profit.