Index Option
Stock options are based on one specific stock. If you buy a contract on Apple
Computers, all you're interested in is how Apple performs. If you buy a
contract on Wal-Mart, you're only interested in the performance of Wal-Mart.
Index options are based on the overall performance of the assets in the
particular index.
Index options offer an investor the chance to take advantage of the market as
a whole or on a specific sector within the marketplace. Index options can
enable an investor to get involved with a wide segment of the market in one
transaction. Being able to match such diversity by purchasing individual
shares of stock would be virtually impossible for individuals with a small
account. Index options can defray the cost of active involvement.
Index options give the buyer more leverage. The buyer can receive a large
percentage of market exposure for a relatively small premium. If the market
does not move as anticipated, the risk is limited to the premium paid.
A stock index can come in many shapes and sizes. Some are broad-based and
measure their moves in broad, diverse markets. Others are narrow-based and
measure more specific industry sectors of the marketplace.
Some index options are constructed so the index is weighted toward the
securities of larger companies, a method known as capitalization-weighted.
Another type of index is the equal dollar-weighted index and assumes an equal
number of shares in each component stock. Some indexes use simple averages.
There's an index option to fit any sort of buyer.
Among the favorite indices today are: The NASDAQ 100 Index (NDX), made up of
the largest non-financial companies listed on the NASDAQ; the S&P 100 (OEX),
100 blue chip stocks; the QQQQ, an exchange-traded fund based on the 100
biggest and most important stocks in the NASDAQ composite; the Dow Jones
Industrial Average Index (DJX), a highly liquid vehicle that allows
speculation on the future direction of the Dow.
Types of Financial Options
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