Equity Option

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Understanding Index & Equity Options

Learn about the details of various types of options trades and why they’re imporant – especially for traders new to options.

If you are trading you may have heard of both equity and index options, but maybe you aren’t sure what the difference is between an American and a European style option? Or perhaps you weren’t aware that some options expire near the market open while others expire at the close of trading. The purpose of this article is to highlight the characteristics of both equity and index options and make sure that you understand the differences, especially when it comes to expiration and the settlement process.

What is an equity option?

An option is a contract between two parties that gives the owner the right to buy (in the case of calls) or sell (in the case of puts) the underlying asset at a specific price up until the expiration date. The “asset” in regards to an equity option is an actual stock or ETF that is exchanged between the two parties after the option is exercised. When a (standard) call is exercised the owner receives 100 shares of the underlying security at the contract’s strike price. Equity options are the most common type of option and are listed on most of the actively traded stocks or ETFs in the market today.

What is an index option?

Similar to equity options, index options have strike prices, expiration dates and can be calls or puts. However, since the underlying is an index rather a stock or ETF the “asset” that gets delivered at expiration is cash. An index is just a number designed to measure the value of a portion of the stock market and therefore cannot be delivered. At expiration, the difference between the value of the index and the strike price (assuming it is in the money at expiration) determines how much cash is delivered. Options are listed on many of the popular indices such as the S&P 500 (SPX), NASDAQ 100 (NDX) and Russell 2000 (RUT).

American style vs. European style

An American-style option allows the owner to exercise the option at any time prior to (and including) the expiration date. Conversely, European-style options can only be exercised at the time of expiration. All equity options are American-style options and the majority of index options are European-style options (exceptions include OEX, XAU, and SOX). While an American-style option offers more flexibility to the option holder, keep in mind that outside of some dividend scenarios, it typically does not make economic sense to exercise an option prior to the expiration date because of the potential time value remaining in the value of the contract. It’s also important to note that both equity and index options can typically be closed out (sold or bought-to-close) prior to the expiration date, assuming an assignment hasn’t taken place.

Expiration and settlement

Excluding weekly and quarterly options, all standard equity options expire on the third Friday of the month at the market close (known as P.M. settlement). The third Friday of the month is generally the last trading day for standard equity options. The official closing price of the stock or ETF on that Friday determines whether the option is in or out-of-the-money. An option that closes $0.01 or more in-the-money falls within the OCC’s price threshold and will be automatically exercised.

Conversely, most standard European-style index options expire near the market open (known as A.M. settlement) on the third Friday of the month and stop trading at the market close on the Thursday preceding that Friday. On that Friday morning an index “settlement value” is calculated once all of the individual securities that make up the index have opened for trading. The settlement value is then used to determine which options are in-and-out of the money and how much cash is to be delivered as a result. There are different ticker symbols for the settlement values of the respective A.M.-settled indices which are updated after the market open on the morning of expiration day. Below are some of the more popular A.M.-settled indices:

Index Name Ticker Symbol Settlement Ticker Symbol
S&P 500 $SPX $SET
Dow Jones Industrial Average $DJX $DJS
Russell 2000 $RUT $RLS
CBOE Volatility Index (VIX) $VIX $VRO

Note: Some SPX weekly options (SPXW) have P.M settlement.

Expiration example (P.M. settlement)

  • Sell the call prior to expiration if you don’t want to take a position in the underlying and you want to capture any remaining value (consisting of either intrinsic value, time value or both).
  • Do nothing and let the closing price determine whether you take a position in AAPL or not
    • If AAPL closes in the money by $0.01 or more you will be assigned and assume a 100 share position in the stock.

If AAPL closes out-of-the-money then the call expires worthless, or

  • Notify Schwab that you don’t want the call to be exercised (known as “do-not-exercise” instructions) with the intention of closing out the position prior to the market close.

Assuming you are comfortable with taking a position in AAPL, you decide to do nothing and let the closing price determine the outcome. By the market close (4:00 PM ET) the closing price of AAPL is $110.18 which means that you will be assigned 100 shares of AAPL at a price of $110.00 before Monday morning.

Expiration example (A.M. settlement)

In this scenario, let’s assume that it is Thursday, November 19th, and you own 1 SPX 11/20/2020 2000.00 call. Since SPX is an A.M.-settled contract, today represents the last trading day for this contract and the expiration of this contract is tomorrow morning. As the owner of the index call option, you understand you have the following choices on the last trading day:

  • Sell the call to realize the current market value of the contract. This might be done in an effort to capture any potential remaining time value and/or if you believe SPX will open lower the next morning.
  • Do nothing and let the call reach expiration Friday morning. The amount of cash deposited in your account depends on the (in-the-money) difference between the strike price of the call (2000) and the settlement value ($SET).

Assuming you feel confident that SPX will open higher Friday morning, you may decide to do nothing and let the call reach expiration. On Friday morning, the SPX initially opens up 6.20 to 2112.25 but the settlement value ($SET) is determined to be 2110.47 roughly 20 minutes after the open. Since the difference between the $SET (2110.47) and the call strike price (2000) is 10.47, you find that $1047.00 (excluding commissions) has been deposited in your account before Monday morning.

Where can I confirm the option type?

You can verify whether an option is American or European style, A.M. or P.M., settled and much more by going to the contract details section. Once you are logged in to schwab.com you can go to “Research” and then “Options” and enter the option symbol to get the contract details. On StreetSmart Edge®, the details are found by going to the option chain and clicking on the yellow arrow starting at the beginning of the row that contains the option contract (see below).

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Finally, below is a snapshot of an example equity and index option to help summarize the differences discussed in this article:

Equity vs. index option comparison

Option Type Equity Index
Exercise Style American European
Expiration Standard Standard
Contract Size 100 AAPL 100 SPX
Multiplier 100 100
Settlement Type P.M. A.M.
Last Trading Day Third Friday of the Month Thursday before the Third Friday of the Month
Delivery 100 AAPL @ strike price $100 x difference between in-the-money strike and SET
Settlement Price Closing AAPL Price $SET Value @ Expiratio

Note: Some SPX weekly options (SPXW) have P.M settlement.
I hope this article helped you gain a better understanding of both equity and index options and what differentiates them. If you have any feedback regarding this article, or any other topics you would like to read, please click on the thumbs up/down icons and leave a comment at the bottom of the page.

Non-Equity Option

What is a Non-Equity Option?

A non-equity option is an option with an underlying asset that is something other than common stock. In most cases, non-equity options include indexes and commodities as underlying assets. It’s really a broad term to define a variety of options, provided the option doesn’t involve common stocks.

Non-equity options usually trade over-the-counter (OTC) Over-the-Counter (OTC) Over-the-counter (OTC) is the trading of securities between two counter-parties executed outside of formal exchanges and without the supervision of an exchange regulator. OTC trading is done in over-the-counter markets (a decentralized place with no physical location), through dealer networks. and come with a specific date on which they can be exercised.

Over-the-Counter Options

Trading options over-the-counter (OTC) affords the parties involved a lot of freedom. It is a private transaction, with a contract that meets the specifications of only the parties involved. No disclosure agreement exists. The terms for trading in such a way are endless and based entirely on the wants and needs of the individuals trading with one another.

OTC trading is appealing for several reasons. It’s done privately, with all negotiations, deals, and agreements being conducted between the parties involved. As long as both sides can eventually come to an agreement that suits all needs, there is the potential for great deals and significant profit once exercised.

The biggest issue with OTC trading of non-equity options is that it’s difficult to maintain liquidity Liquidity In financial markets, liquidity refers to how quickly an investment can be sold without negatively impacting its price. The more liquid an investment is, the more quickly it can be sold (and vice versa), and the easier it is to sell it for fair value. All else being equal, more liquid assets trade at a premium and illiquid assets trade at a discount. . Options can’t always be closed out by selling them to someone else before the date of expiration. When traded OTC, one of the parties involved must find a different party to create an opposing contract with. It would then offset the initial contract/position and boost liquidity.

Functions of Non-Equity Options

Non-equity options are often sought out because of the factors mentioned in the section above. However, they’re also ideal for many investors because of how they function.

One of the most important functions that a non-equity option can fulfill is allowing an investor to hedge against price movements, thereby eliminating risk. The investor may be trading a number of other positions on exchanges Types of Markets – Dealers, Brokers, Exchanges Markets include brokers, dealers, and exchange markets. Each market operates under different trading mechanisms, which affect liquidity and control. The different types of markets allow for different trading characteristics, outlined in this guide and use the option to offset any losses that such investments may incur.

Non-equity options make sense because by helping an investor hedge against risk; they enable him to keep a well-balanced portfolio. He enjoys more freedom to execute trades and take positions, knowing that if the positions rise or fall in a significant way, he can use a non-equity option to restore the balance.

Trading Strategies

Non-equity options are afforded the same strategy options as exchange-traded options. Two or more options may be used together, and simple put and call strategies are possible as well.

Many options that are traded on exchanges, including currency options and gold options. They, of course, don’t enjoy the same flexibility as non-equity options, which are traded over-the-counter. The exchange – not the parties involved – establish the terms of the contract, what the strike prices Strike Price The strike price is the price at which the holder of the option can exercise the option to buy or sell an underlying security, depending on whether they hold a call option or put option. An option is a contract with the right to exercise the contract at a specific price, which is known as the strike price. are, and when the options expire. They are why OTC non-equity options are often preferred because buyer and seller are free to negotiate every aspect of the transaction privately.

More Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ FMVA® Certification Join 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Futures and Forwards Futures and Forwards Future and forward contracts (more commonly referred to as futures and forwards) are contracts that are used by businesses and investors to hedge against risks or speculate. Futures and forwards are examples of derivative assets that derive their values from underlying assets.
  • Guide to Commodity Trading Guide to Commodity Trading Secrets Successful commodity traders know the commodity trading secrets and distinguish between trading different types of financial markets. Trading commodities is different from trading stocks.
  • Options: Calls and Puts Options: Calls and Puts An option is a form of derivative contract which gives the holder the right, but not the obligation, to buy or sell an asset by a certain date (expiration date) at a specified price (strike price). There are two types of options: calls and puts. US options can be exercised at any time
  • Spot Price Spot Price The spot price is the current market price of a security, currency, or commodity available to be bought/sold for immediate settlement. In other words, it is the price at which the sellers and buyers value an asset right now.

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Risk glossary

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Equity option

An equity option gives the holder the time-limited right, but not the obligation, to buy or sell an instrument at a predetermined price, in exchange for a premium payment. A call option gives the buyer the right to purchase shares from the seller at the pre-set strike price. A put option gives the buyer the right to sell shares to the seller at the strike price.

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