Index, Interest Rate And Currency Options - Index Option Settlement

Investors who want to take a position in index options will purchase calls and puts just like investors in stock options. However, an index is not a security and cannot be physically delivered if the option is exercised. An investor cannot call the index away from someone who is short a call and cannot put an index to an investor who is short a put. As a result, the exercise of index options will be settled in cash. An option holder who elects to exercise the option will have their account credited the in the money amount, in cash. The amount that will be credited to their account will be the in the money amount at the close of the market on the day of exercise. The exercise of an index option settles between broker dealers on T + 1 and customer accounts will be credited or debited accordingly. To determine the option’s premium and the amount of money to be delivered upon exercise index options, use 100 as a multiplier.

Example:

An investor establishes the following position:

Long 1 OEX March 550 call at $4

The investor has purchased an S & P 100 (OEX) 550 call for $4. The contract value is 55,000 and the total premium paid by the investor is $400. The investor is bullish on the overall market and believes the market will rise and the OEX will be higher than 550 by expiration.

If at expiration, the index is at 556.20, the investor will have their account credited the in the money amount as follows:

556.20 - 550.00 = 6.20

6.20 x 100 = $620.00 

The investor’s account will be credited $620. Since the investor paid $400 for the option their profit is $220.

 

Series 4 sample questions

Exercising An Index Option
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