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).