Interest in Index Options Continue to Grow–Find Out Why

December 17, 2024 at 08:55 AM EST

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By Cboe

With investors and traders becoming more knowledgeable, the sophistication of their investment strategies is increasing, as evidenced by the growing usage of derivative instruments, particularly options. The growth in average daily volumes in U.S. options has been gradually increasing. The reported volume was 44 million in 2023, up from 41 million in 2022 and more than double 2019 levels, according to the Options Clearing Corporation (OCC). Year to date, as of November 2024, the average daily volume is over 48 million, approximately 8% higher than last year’s at the same point in time.

In reviewing the OCC’s monthly report, it can be observed that index options are among the instruments exhibiting consistent growth – highlighting investors' increasing adoption. Validation of this observation is further shown in the market environment, as Cboe Global Markets (CBOE: CBOE), the world's leading derivatives and securities exchange network, recently announced that their index options will be made available on Robinhood Markets Inc.’s (NASDAQ: HOOD) platform.

Below, we dive into the value proposition for this investment offering and the potential benefits of trading index options.

Index Options Explained

Index options allow investors and traders to take a directional position on an entire market. The underlying asset is usually a broad market index, such as the S&P 500 Index or NASDAQ 100 Index. Interested investors with a strong view of how the broad stock market will move could consider trading index options, but remember, options involve risk. Index options provide investors with the right, but not the obligation, to buy or sell the index at a predetermined price before the option's expiration date. The pricing of these options is influenced by several factors, including the underlying index's price, the strike price, time to expiration, interest rates, dividends and implied volatility.

The Versatility Of Index Options

As mentioned earlier, index options offer the opportunity to trade based on one’s directional view of the overall market – bullish, bearish or neutral. Practically speaking, options enable investors to speculate or hedge against movements in the broader market. If one anticipates the market will have an upswing, traders and investors can use call index options to capitalize on the movement. Conversely, to hedge against a market downturn, put index options can help mitigate losses to the portfolio.

Another practical use of index options is income generation, as investors and traders can sell covered calls or cash-secured puts and collect premiums as income.

The Benefits Of Index Options

The primary benefit of index options is their broad market exposure and diversification, as they allow investors and traders to trade on an entire index. A secondary but functional benefit of index options is that they are cash-settled, which means that the buyer of an option contract receives the cash difference between the strike price and the current market price of the underlying security. Practically speaking, given that the underlying asset is an index, physical settlement is not feasible; hence, the buyer receives an amount of cash equal to the underlying asset's value when the option is exercised. Finally, index options allow investors and traders to control large positions with relatively small capital outlays. Cboe’s XSP® (Mini-SPX) represents one-tenth of the value of the standard S&P 500 Index option (SPX®) but provides investors and traders control of large positions.

Utilizing Index Options

For individuals looking to trade index options, Cboe Global Markets has multiple offerings for products that offer exposure to the S&P 500 as well as FTSE Russell indices. Though each index option offering's intended audience is distinct, the value proposition provided by each is consistent.

Cboe Nanos are unique due to their small size and simplicity, especially since they trade at one-hundredth the size of an XSP contract. The specific sizing makes them accessible to investors and traders with limited capital, enabling them to capitalize on market movements at a limited cost outlay, albeit with increased risk. For individuals familiarizing themselves with index options, Cboe Nanos can be a potentially easier pathway to learn about trading these instruments.

Though the Cboe XSP is one-tenth the value of the standard S&P 500 Index option, its scaled-down nature makes it more affordable and accessible for smaller investors while maintaining much of the benefits derived from index options. Cboe XSP is typically traded by retail and smaller institutional investors and traders.

Finally, Cboe SPX, Cboe Global Markets' leading index option offering, provides extensive exposure to the S&P 500 Index, making it ideal for speculating on market movements or hedging portfolio risk. SPX is typically traded by institutional investors and high-net-worth investors, although retail trading of SPX has increased in recent years.

Taking Action With Cboe’s Index Options

Index options provide investors and traders with increased optionality regarding gaining market exposure, managing risk and enhancing their return profile. Cboe’s index options allow for access to diversified markets, provide cash settlement and offer multiple contract sizes and expiries, allowing traders flexibility and choices. With the right education and experiential knowledge, index options can be a valuable component of an investor or trader’s portfolio management strategy.

Cboe offers The Options Institute, an educational platform that allows both beginners to options trading and professional traders a forum to familiarize themselves with foundational knowledge on options or learn of new developments taking place within the investment derivatives landscape. The Options Institute provides comprehensive courses and tools, equipping investors with the knowledge needed to navigate the complexities of options trading effectively.

It is important to remember that responsible options trading is based on defining an investment objective and using analysis and informed decision-making to determine the most appropriate trading strategy, not emotions. Understanding how options work and the associated risks, just like any other financial asset, is paramount.

Featured photo by Nicholas Cappello on Unsplash.

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