Structured Index Options
In addition to trading options directly, you can buy or sell positions in one of many "structured" products offered by one of the exchanges involved with index options. The CBOE offers many structured products aimed at specific index positions or strategies.
Smart Investor Tip
The CBOE offers options on over 40 market indices. To investigate further, check the CBOE web site at www.cboe.com
and go to the link "Index Options Overview."
Related options are also available on index-like products, including exchange-traded funds (ETFs)
. An ETF is a type of mutual fund with a predetermined basket of stocks, which trades on the public exchange just like stocks (as opposed to having to buy or sell shares through the fund's management).
Because the portfolio of an ETF is known in advance, investors do not have to rely on quality of management to make wise investment decisions. The CBOE facilitates trading of options on ETFs, which are settled in cash using American-style exercise rules. In some ETFs, the CBOE also offers long-term equity anticipation security (LEAPS) options. Every ETF has a theme or characteristic. For example, ETFs specialize in specific sectors, countries, or types of securities, making it possible to participate in very narrowly focused markets and hold proportionate values of many stocks with a single position. For this reason, the ETF form of mutual fund functions very much like an index, but with a narrower focus. CBOE also offers options on holding company depositary receipts (HOLDRs)
, which are trust-issued receipts of beneficial ownership in groups of stocks. Originally created by Merrill Lynch, HOLDRs today are popular alternatives to market indices and ETFs. However, because the value of HOLDRs changes with market and sector trends, they are very similar to indices but, like ETFs, are more focused.
Smart Investor Tip
For more information about options on ETFs or HOLDRs through the CBOE, check their web site (www.cboe.com) and go to the link "Options on ETFs & HOLDRs."
CBOE also provides interest rate options, including options on U.S. Treasury securities; on futures through its own CBOE Futures Exchange; and on specialized types of options, including binary options
. These are options based on the S&P 500 Index or on the CBOE Volatility Index. With different strike prices available, binaries trade much like stock-based options, but with one important difference. The buyer of a call binary option is paid $100 at close if the underlying index is higher than the call's strike. If the underlying index is lower, the call buyer gets nothing. A put buyer receives $100 in the underlying index closes below the binary strike; if it is higher, the put buyer gets nothing. The long position of binary calls and puts can be closed before expiration, if desired. Premium levels for binary options vary between $1 and $100 per contract at the time of purchase, which varies depending on proximity between index level and strike and time until expiration. The CBOE also markets short-term options with life spans of a single week or quarter. These are weeklys
Weeklys are issued each Friday and expire the following Friday. They are good alternatives to trading traditional stock options with timing at or near important events like earnings announcements or dividend dates. The quarterlys are issued on the final business day of each calendar quarter, and they expire three months later. Yet another innovation is the flexible exchange (FLEX)
option, a CBOE product whose terms can be modified. These include the expiration date, striking price, and exercise terms (American or European). In addition to providing FLEX options on several individual stocks, the CBOE also offers them on the S&P 500, S&P 100, Nasdaq 100, Russell 2000, and Dow Jones Industrial Average. A great deal of variety and flexibility in the markets for index options and similar products makes option investing far more expansive than the traditional stock-based option. While the range of strategies available on traditional listed options continues to make this the most appealing to the greatest number of traders, index option trading has great potential. It broadens the possibilities for diversification of a stock portfolio and for creative advanced strategies. As with all types of options, the risk levels involved should rule the decision to use to not use a particular strategy or type of option. Another concern is how profits will be treated and timed for tax purposes.
By Michael C. Thomsett