8.5 Index and Non-Equity Options

Index Options

Beyond single-stock options, the Series 7 covers options on broad market indices. The most-tested are the S&P 500 (SPX), the Dow Jones Industrial Average (DJX), the Nasdaq-100 (NDX), and the CBOE Volatility Index (VIX), often called the "fear gauge."

How index options differ from equity options

*The OEX (S&P 100) is a notable American-style index option.

Cash settlement

When an index option is exercised, no securities change hands. The holder receives the intrinsic value in cash, based on the closing index level.

Example: An investor holds an SPX 5,000 call and the index closes at 5,050.

• Intrinsic value = 5,050 − 5,000 = 50 points
• Cash received = 50 x $100 = $5,000

Exam alert: Because index options are cash-settled and usually European-style, a writer cannot be assigned early and never has to deliver or receive actual stock — a frequent comparison point against early assignment risk on American equity options.

Hedging a Portfolio with Index Options

An investor who owns a diversified, market-correlated portfolio can buy index puts to insure against a broad decline without liquidating individual positions and triggering taxes or transaction costs.

If a $500,000 portfolio has a beta of 1.0 versus the S&P 500, the investor buys enough SPX puts so that the notional value (index level x $100 x number of contracts) approximates the portfolio's value. Higher beta means more contracts are needed; lower beta means fewer. This is the index-level equivalent of the protective put from Section 8.3.

LEAPS

LEAPS (Long-Term Equity Anticipation Securities) are simply long-dated options, available on both individual stocks and indices. They are listed for terms up to about 39 months (commonly described as roughly three years) and always carry a January expiration.

Use case: LEAPS give long-term leverage or long-term portfolio insurance without the constant rolling that short-dated options require. The trade-off is a larger premium outlay and thinner trading volume.

Foreign Currency Options

Currency options grant the right to buy or sell a foreign currency at a set exchange rate. Note that the U.S. dollar itself is not optionable; investors trade options on foreign currencies (euro, yen, pound, etc.).

• Contract size: varies by currency.
• Settlement: generally cash or physical depending on the contract.
• Use: an importer/exporter hedges currency risk; speculators bet on exchange-rate moves.

Example: A U.S. company expecting to receive €100,000 in three months fears the euro will fall. It buys euro puts (the right to sell euros at a fixed rate), locking in a minimum dollar value. A company that must pay in euros would instead buy euro calls.

Interest-Rate Options

These come in two flavors, and the exam tests how each reacts to rate changes:

• Price-based (debt) options track a bond's price, which moves inversely to rates.
• Yield-based options track the yield itself, which moves directly with rates.

Exam tip: The classic trap reverses the price/yield relationship. A yield-based call gains when rates rise; a price-based call on a bond gains when rates fall (because the bond's price rises). Identify whether the option references price or yield before answering.

Non-Equity Options at a Glance

Putting It Together

Non-equity options extend the same right-versus-obligation framework to broader exposures. An institution hedging a stock portfolio reaches for index puts; an exporter hedging foreign receivables reaches for currency puts; a bond manager fearing a rate spike reaches for a yield-based call or a price-based put. The multiplier remains $100 for both equity and index contracts, so dollar calculations carry over directly from Sections 8.1 and 8.2.

Common trap: Remember that index options are usually European-style and cash-settled, so the writer faces no early assignment and never delivers shares — a frequent point of contrast with American-style equity options that can be assigned at any time.