- October 10, 2022
- Posted by: CoachShane
- Category: Trading Article
When Options trading, you have many different types of instruments at your disposal. For the most part, they can be summed up under two categories: equity and index options. But what exactly are they? Which one is better for investors?
In this post, we’ll break down equity and index options, their benefits, and what factors to consider when making your investment decision.
What Are Equity Options?
An equity option (American style options) is a contract that grants the holder the right, but not the obligation, to buy or sell a specific number of shares of stock at a specified price within a specific time period. Equity options are traded on various exchanges in the United States and around the world.
The shares underlying an equity option can be stocks, Exchange Traded Funds (ETFs), or even real estate investment trusts (REITs). The underlying instrument of an equity option contract is 100 shares of that instrument. Example: 1 Options contract of META would contain 100 shares of Meta Stock
There are two types of options: call options and put options. A call option gives the option buyer the right to buy the underlying security, while a put option gives the holder the right to sell the underlying security.
The price at which an option can be exercised is known as the strike price. The strike price is the price that the trader expects the underlying instrument to be above for a call, or below for a put, at expiration.
Options contracts have expiration dates, after which they are void. The expiration date for most equity options is the third Friday of every month.
Using the META Option Chain above, notice the green highlight for a call option:
Strike price: $145.00
Expiration Jan 20, 2023
Last: Transaction was $14.50
To buy this call option using the last transaction, it would cost you $14.50 per share or 14.50 X 100 shares = $1450.00
As a trader, you want the stock price of META to be above $145.00 (plus premium paid of 14.50) by expiration in order for you to profit.
When an equity option is exercised (only about 7% of contracts are exercised), shares of stock are exchanged between the buyer and seller of the option. If a call option is exercised, then shares of stock are transferred from the seller to the buyer. If a put option is exercised, then shares of stock are transferred from the buyer to the seller.
Most traders will sell to close their options position before expiration and book a profit or a loss depending on what the underlying instrument did.
What Are Index Options?
An index option is similar to an equity option, except that instead of shares in a particular stock or ETF, an index option gives the holder the right to buy or sell shares in an entire stock market index. The most common index options are based on the S&P 500 and NASDAQ-100 indexes.
Most index options are called European-style options. Unlike equity options, index options can only be exercised at expiration. That expiration day is the Thursday before the third Friday of the month. The settlement price (exercise price) is known the next business day around the market opening.
When you exercise an equity options contract, you would receive the shares of the underlying. With index options, you would receive a cash settlement for the intrinsic value of the contract.
For example, let’s say the S&P 500 index is currently trading at $3670.00. The strike price of your call option is $3675.00 and at expiration, that is the price of S&P. The intrinsic value is $5 or $500 per contract.
Another feature of Index options is because indexes are composed of different underlying companies, they’re less volatile than just trading an individual stock. When some of the underlying moves up, others move down. This can offset some of the extreme volatility you can get trading a singular underlying asset.
What Are the Benefits of Equity Options?
Some of the benefits of equity options include:
Offer traders a high degree of control and flexibility when it comes to managing their portfolios
They can be used to hedge against risk by offsetting positions in other investments
Offer opportunities for traders to profit from both rising and falling markets through calls, puts, and various option strategies
What Are the Benefits of Index Options?
Index options offer investors several advantages as well, including:
They provide exposure to large numbers of stocks with a single investment
Tend to be more liquid than individual stocks, meaning there is usually no problem finding a buyer or seller when you want to trade them
They are often less volatile than trading an Equity option
Which Is Better for Investors?
So which should you choose when trading options —equity options or index options?
The answer ultimately depends on your investment goals and objectives.
If you’re looking for more control over your portfolio and the ability to hedge against risk, equity options may be the better choice. If you’re interested in gaining exposure to a large number of stocks with a single investment with potentially less volatility, index options may be more of interest.
When it comes to choosing between equity and index options, there is no clear-cut answer. It all depends on your investment goals and objectives.
Because equity options offer traders considerable flexibility and opportunities for profit, they have become popular instruments in today’s investment markets and a favorite here at Netpicks.
Hope that this post has given you a better understanding of these two types of options so that you can make an informed decision about which one is right for you. Seeking investment advice before you risk your money is always the prudent thing to do.
Let Us Help
Imagine what it would feel like to have the power to control your financial future.
That’s what options trading can do for you – give you the ability to make money regardless of market conditions. And with our help, you can achieve this goal in just 8 minutes a day.
Download our free Options Cookbook to get an inside look at how we successfully approach options trading