Index Options and Market Risk Portfolio Review

These vocabulary flashcards cover the characteristics of various index options (SPX, OEX, DJX, RUT, VIX), their exercise styles, settlement procedures, payoff calculations, and their use in hedging systematic risk.

Index options

Options contracts that derive their value from fluctuations in a specific index’s value, allowing investors to speculate on general market movements or protect portfolios from market risk.

SPX

An index option that tracks the S&P 500, which represents $500$ large-cap US traded companies.

OEX

An index option tracking the S&P 100 ($100$ large-cap US traded companies); it is a notable exception as an American style index option.

DJX

An index option that tracks the Dow Jones Industrial Average, which consists of $30$ large-cap US traded companies.

RUT

An index option that tracks the Russell 2000, which consists of $2,000$ small-cap US traded companies.

VIX

The Volatility index that tracks the volatility of the market.

European style

An exercise style where options can only be exercised at expiration; this applies to virtually all index options with the exception of the OEX.

American style

An exercise style where options can be exercised at any time; this applies to all equity options and the OEX index option.

Cash settlement

The settlement method for index options where the writer pays the in-the-money amount (intrinsic value) in cash to the holder, as no physical shares are bought or sold.

Index option exercise settlement time

The time frame for settling an index option exercise, which occurs over one business day ($T+1$).

Long call maximum gain (Index)

Unlimited; as the index rises further above the strike price, the investor's profit potential continues to increase.

Long call maximum loss (Index)

The total premium paid, calculated as the premium amount multiplied by a $100$ multiple.

Short put maximum loss (Index)

Calculated as ($\text{strike price} - \text{premium}$) multiplied by the $100$ multiple; this loss occurs if the index falls to zero.

Systematic risk

Also known as market risk, this is risk that applies to a large segment or the entire market and cannot be mitigated through diversification.

Hedging with index puts

A strategy where investors with large, diversified portfolios buy long index puts to produce gains that can offset losses during broad market declines.