Equity vs. Index Options
Options cover more than individual stocks. They also cover entire market indexes, and the differences between these two types affect settlement, exercise style, and hedging use.
Equity Options
- Based on an individual stock (e.g., options on Apple, Microsoft, Tesla)
- Standard contract = 100 shares of the underlying stock
- Physical delivery - actual shares change hands when exercised
- If you exercise a call, you receive 100 shares; if you exercise a put, you deliver 100 shares
- Usually American style (can be exercised any time before expiration)
Exam Tip: Gotchas
- Not all options involve physical delivery. Only equity options deliver actual shares. Index options settle in cash.
Index Options
- Based on a stock index (e.g., S&P 500, Nasdaq 100, Russell 2000)
- Cash settled - no physical delivery of securities
- When exercised, the difference between the strike price and the index level is paid in cash
- Multiplier is typically $100
- Usually European style (can only be exercised at expiration)
- Used to hedge a diversified portfolio against broad market risk
Side-by-Side Comparison
| Feature | Equity Options | Index Options |
|---|---|---|
| Underlying | Individual stock | Stock index |
| Settlement | Physical delivery | Cash settlement |
| Exercise style | Usually American | Usually European |
| Contract size | 100 shares | $100 multiplier |
| What it hedges | Individual stock risk | Market/portfolio risk |
Why This Matters for Hedging
- Own a single stock? Use equity options to hedge that specific position
- Own a diversified portfolio? Use index options to hedge against broad market declines
- Portfolio managers commonly buy S&P 500 index puts to protect against market downturns
Exam Tip: Gotchas
- Index options are cash settled. You cannot deliver "shares" of an index because an index is a calculation, not a security you can own.
- European style has nothing to do with Europe. It means the option can only be exercised at expiration (not any time before, like American style).