Index and Non-Equity Options

The Series 7 exam covers specialized options beyond standard equity options, including index options, foreign currency options, and interest rate options.

Index Options

Index options are based on stock market indices rather than individual stocks. The most commonly traded include:

• S&P 500 Index (SPX) - Broad market index
• Dow Jones Industrial Average (DJX) - 30 large-cap stocks
• Nasdaq 100 (NDX) - Technology-heavy index
• VIX - Volatility Index ("Fear Gauge")

Key Differences from Equity Options

*Some index options (like OEX) are American-style.

Cash Settlement

When an index option is exercised, no securities change hands. Instead, the holder receives the intrinsic value in cash.

Example: An investor holds an S&P 500 2000 Call when the index closes at 2050.

• Intrinsic Value = 2050 - 2000 = 50 points
• Cash Settlement = 50 × $100 = $5,000

Exam Alert: Cash settlement eliminates assignment risk for index option holders but also removes the possibility of receiving or delivering actual securities.

Using Index Options for Portfolio Hedging

Investors use index options to protect diversified portfolios without selling individual holdings.

Protective Put Example

An investor with a $500,000 portfolio correlated to the S&P 500 could buy SPX put options to protect against a market decline.

If the portfolio has a beta of 1.0, buying puts on the equivalent index value provides hedge protection during market downturns.

LEAPS (Long-Term Equity Anticipation Securities)

LEAPS are long-term options with expiration dates up to 3 years from issuance.

LEAPS Characteristics

Use Case: LEAPS are popular with investors who want long-term leverage or protection without the frequent rolling required with short-term options.

Foreign Currency Options

Currency options give the holder the right to buy or sell a specific foreign currency at a predetermined exchange rate.

Key Features

• Contract Size: Varies by currency (typically 10,000 or 100,000 units)
• Settlement: Physical delivery of currency
• Use: Hedging international business exposure or speculation on currency movements

Example

A U.S. company expecting to receive €100,000 in 3 months could buy EUR put options (or USD call options) to protect against euro depreciation.

Interest Rate Options

Options on interest rate instruments, including:

• Treasury options - Based on Treasury securities
• Yield-based options - Based on Treasury yields

Interest Rate Relationship

Exam Tip: Remember the inverse relationship between interest rates and bond prices. This affects how interest rate options behave.