Index Option Trading Section

Index Option Trading Section

Before we start speaking about index option trading let us define what an index actually is. According to economic encyclopedias, an index is a statistical gauge of changes in economy or securities markets. It lists different stocks that have something in common and represents their overall value. In other words, this is a notional securities portfolio reflecting a market on the whole or its portion. Some indices are broad, others are concerned with a specific group. An index can enumerate companies specializing in the same field or having similar styles of management. Some foreign indices reflect the total value of foreign stocks. Technically, you invest not in the index itself but in an index fund or another security tracking it.

Indices are usually expressed basing on shifts from their basic value. They help evaluate economy progress and the general situation on the stock market.

In the United States, three major indices can be distinguished. They are: the Nasdaq Composite, Dow Jones Industrial Average (“the Dow” or “the DJIA”) and the Standard & Poor's 500 (S&P 500). Altogether, these indices are called 'Security Market Indicator Series'.

Indices are classified according to the way they are weighted. For example, the DJIA is a price-weighted index, that is, each stock influences the whole index basing on its price per share. Stocks that cost more will have more weight and impact on the market, too.

The S&P 500 is a market-value weighted index. It means that the weight of each stock is proportional to its value in the market.

Index option trading is considered less risky than stock option trading as it is unlikely that the value of a specific company in the index will abruptly fall. They facilitate performance trend analysis and form a part of most Mutual Fund portfolios. Investors occupied with index option trading bet on the movement of the stock market as a whole.

You can also find some information on individual stocks option trading and basic terminology used in option trading in our articles on Stock Option Trading and Basic Option Trading Concepts.