Stock Index Options
Stock Index Options
Stock index options
work the same as regular options except that instead of being pegged to
the market price of an underlying stock, they are pegged to the price of the entire market.
Huh? We will get into stock indexes in detail in Lesson 15, "The Ticker Tape, Stock
Indices, and Other Media," but for our present purposes let's use this next example.
Stocks and derivatives are bought and sold like anything else in markets. Let's use your local
farmer's market as an example. You are not the guy selling tomatoes at the market, but
rather the guy who owns the land on which the market sits. You make your money renting
booths to sellers at the farmer's market. You notice that these days the tomato seller is
making more money selling tomatoes than she used to, and you're wondering if you should
be charging more for booth spaces. How do you figure out whether the entire market is
making more money than it used to?
You could add up the individual sale prices of all the items (tomatoes, corn, flowers, etc.) at
last year's market and then divide the total by the number of items on the list. This would give
you a very rough average price of the items for sale. If a year later you added up the current
prices of those same items and divided the total by the same number, you would probably
get a different average. If the new average were higher, it's a pretty safe bet all the sellers at
the market were making a little more than they used to and you should raise your booth rent
proportionately. If the new average were lower or stayed the same, you should probably
consider leaving your prices as they are, or even reducing them.
Plain English
Stock index options are options to buy or sell stock whose price represents the
value of the entire market at a predetermined price, regardless of the actual value of
the market.
