The trading world has evolved at an exponential rate since the mids. Fueled in large part by the vast expansion of technological capabilities - and combined with the ability of financial firms and exchanges to create new products to address each new opportunity - investors and traders have at their disposal a vast array of trading vehicles and trading tools.

In the mids, the primary form of investment was simply to buy shares of an individual stock in hopes that it would outperform the broader market averages. Around this time, mutual funds started to become more widely available which allowed more individuals to invest in the stock and bond markets. In , stock index futures trading began. This marked the first time that traders could actually trade a specific market index itself, rather than the shares of the companies that comprised the index.

From there things have progressed rapidly. First came options on stock index futures, then options on indexes, which could be traded in stock accounts. Next came index funds, which allowed investors to buy and hold a specific stock index. The latest burst of growth began with the advent of the exchange-traded fund ETF and has been followed by the listing of options for trading against a wide swath of these new ETFs.

A market "index" is simply a measure designed to allow investors to track the overall performance of a given combination of investment instruments. While such market indexes track the "big picture" of price trends, the fact is that for most of the 20th century the average investor had no avenue available to actually trade these indexes. With the advent of index trading, index funds and index options that threshold was finally crossed. Other families including Guggenheim Funds and ProFunds took things to an even higher level by rolling out, over time, a wide variety of long, short and leveraged index funds.

An Introduction To Sector ETFs. The next area of expansion was in the area of options on various indexes. The listing of options on various market indexes allowed many traders for the first time to trade a broad segment of the financial market with one transaction. The Chicago Board Options Exchange CBOE offer listed options on over 50 domestic, foreign, sector and volatility based indexes.

A partial listing of some the more actively traded index options on the CBOE by volume as of September appears in Figure 1. The first thing to note about index options is that there is no trading going on in the underlying index itself.

It is a calculated value and exists only on paper. The options only allow one to speculate on the price direction of the underlying index, or to hedge all or some part of a portfolio that might correlate closely to that particular index.

ETFs and ETF Options An ETF is essentially a mutual fund that trades like an individual stock. As a result, anytime during the trading day an investor can buy or sell an ETF that represents or tracks a given segment of the markets. The vast proliferation of ETFs has been another breakthrough that has greatly expanded the ability of investors to take advantage of many unique opportunities.

As with index options, some ETFs have attracted a great deal of option trading volume while the majority have attracted very little.

Figure 2 displays some of the ETFs that enjoy the most attractive option trading volume on the CBOE as of September While ETFs have become immensely popular in a very short period of time and have proliferated in number, the fact remains that the majority of ETFs are not heavily traded. This is due in part to the fact that many ETFs are highly specialized or cover only a specific segment of the market. As a result, they simply have only limited appeal to the investing public.

The key point here is simply to remember to analyze the actual level of option trading going on for the index or ETF you wish to trade.

The other reason to consider volume is that many ETFs track the same indexes that straight index options track, or something very similar. Therefore, you should consider which vehicle offers the best opportunity in terms of option liquidity and bid-ask spreads. There are several important differences between index options and options on ETFs.

The most significant of these revolves around the fact that trading options on ETFs can result in the need to assume or deliver shares of the underlying ETF this may or may not be viewed as a benefit by some. This is not the case with index options. The reason for this difference is that index options are " European " style options and settle in cash, while options on ETFs are "American" style options and are settled in shares of the underlying security.

American options are also subject to "early exercise," meaning that they can be exercised at any time prior to expiration, thus triggering a trade in the underlying security. Index options can be bought and sold prior to expiration, however they cannot be exercised since there is no trading in the actual underlying index. As a result, there are no concerns regarding early exercise when trading an index option. The amount of option trading volume is a key consideration when deciding which avenue to go down in executing a trade.

This is particularly true when considering indexes and ETFs that track the same - or very similar - security. Both SPY and SPX trade in great volume and in turn enjoy very tight bid-ask spreads. This combination of high volume and tight spreads indicate that investors can trade these two securities freely and actively.

At the other end of the spectrum, option trading on IVV is extremely thin and the bid-ask spreads are significantly higher.

In choosing between trading SPX or SPY a trader must decide whether to trade American style options that exercise to the underlying shares SPY or European style options that exercise to cash at expiration SPX.

The trading world has expanded by leaps and bounds in recent decades.

Interestingly, the good news and the bad news in this are essentially one and the same. On one hand we can state that investors have never had more opportunities available to them. At the same time the average investor can easily be confused and overwhelmed by all of the possibilities that swirl around him or her. Trading options based on market indexes can be quite profitable.

Deciding which vehicle to use - be it index options or options on ETFs - is something that you should give some serious consideration to before "taking the plunge.

Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund. Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin? This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam.

Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Index Options By Jay Kaeppel Updated October 24, — 8: The Lowdown On Index Funds An Overview of Index Trading A market "index" is simply a measure designed to allow investors to track the overall performance of a given combination of investment instruments. An Introduction To Sector ETFs The Advent of Index Options The next area of expansion was in the area of options on various indexes.

Some major market indexes available for option trading on the CBOE. Foreign and Domestic Stock Indexes large-cap, small-cap, growth, value, sector, etc. Currencies yen, euro , pound, etc. Commodities physical commodities, financial assets , commodity indexes, etc.

Bonds treasury, corporate, munis international As with index options, some ETFs have attracted a great deal of option trading volume while the majority have attracted very little. ETF Ticker SPDR Trust SPY iShares Russell Index Fund IWM PowerShares QQQ Trusts QQQQ iShares MSCI Emerging Markets Index EEM SPDR Gold Trust GLD Financial Select SPDR XLF Energy Select SPDR XLE SPDR Dow Jones Industrial Average ETF DIA Market Vector Semiconductors ETF SMH Market Vector Oil Services ETF OIH Figure 2: ETFs with Active Option Trading Volume.

The Basics Of The Bid-Ask Spread Difference No.

How to Trade Leveraged ETF Options

Quantifying The Differences Difference No. The Bottom Line The trading world has expanded by leaps and bounds in recent decades. Here's help in making the decision.

Options on Exchange-Traded Products

Index options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction. With more ETFs to trade, the risks associated with these investments have grown. To mitigate these risks, ETF options are a hedging strategy for traders. Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.

Learn about exchange-traded fund ETF options and index futures, and why it might be a better decision to use ETF options instead of futures.

Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs. This vehicle combines the diversification of a mutual fund with the flexibility of a stock. Learn more about them here. Learn about stock index options, including differences between single stock options and index options, and understand different Learn what exchange-traded funds ETFs are and their advantages to investors, what a portfolio of ETFs is, and discover An exchange-traded fund ETF is a security that tracks an index but has the flexibility of trading like a stock.

Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your Learn how the strike prices for call and put options work, and understand how different types of options can be exercised An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money.

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Call and Put Options Explained: An ETF Perspective

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