Stock index options are pegged to the performance of a stock market index. “Call” options give you the right to buy an index. “Put” options give you the right to sell the index.
Both types of options may be bought or sold; they all can be exercised at a given price, up to a certain date.
Puts and calls can provide the opportunity to earn big profits, even though the broad stock market is making modest moves. For example, consider OEX options on the S&P 100 index. Say the S&P 100 index trades at 750. Thus, each OEX option covers $75,000 (750 times $100) worth of stock.
Options to buy the index at 750, with expiration in one month, might be listed around $1,500. (The newspaper listing would be 15 but you multiply that by $100 to get the price.)
If the stock index goes up, so will your option. Suppose the index trades at 800 at the expiration date. You have the option to buy at 750, 50 points below the market price, so your contract now is worth about $5,000: 50 times $100. In this example you bought the option a month earlier for $1,500, when the index was at 750.
Thus, while the index went up 50 points, about 7%, you more than tripled your money (invested $1,500 and received $5,000), for a 200%-plus profit.
On the other hand, suppose you buy an OEX option at 750, the option falls below that level, and never recovers. Your option will expire worthless.
Unless you “close your position” — sell the call option you bought before expiration — your $1,500 investment will be a total loss. Even if you do sell you’ll likely take a significant loss on the option if the index has dropped.
Get Education on Options First
These are only a few of the many aspects of option trading. To find out more about options, visit the Chicago Board Options Exchange Web site (www.cboe.com) or the Options Industry Council site (www.888options.com) for tips and insights before you start trading.