Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

OEX

What it is:

OEX is the ticker symbol of index options on the S&P 100, which trade on the Chicago Board Options Exchange (CBOE).

How it works (Example):

The Standard & Poor's 100 index (S&P 100) is a subset of the famous S&P 500 index. It is composed of the 100 largest cap companies in the S&P 500 and spans several industry groups. Introduced in 1976 with a base value of 50, the S&P 100 is a measure of performance for the large-cap sector.

Although the S&P 100 is not as popular as the S&P 500, it is an important, market-weighted benchmark for many fund managers who invest in this large, blue-chip segment. The stocks are chosen based on market capitalization, liquidity and industry representation. To be included in the index, individual stock options must be available for the stock, and the stock must have at least a 50% public float, among other things.

Introduced in 1981, index options are call or put options on a financial index comprising many stocks. They are essentially bets on the overall movement of the market or a basket of stocks. Index options usually have a contract multiplier of $100, meaning that the price of an index option equals the quoted premium times $100. Unlike options in shares of stock or even commodities, it's not possible to physically deliver the underlying index to the purchaser of an index option. Thus, index options settle via cash payments.

A variety of mutual funds and ETFs also track the S&P 100.

Why it Matters:

Hedgers and speculators can use OEX options to get exposure to an entire market or entire sector in a single, quick transaction as well as protect against downturns and lock in gains. Though it is impossible to forecast exactly how a portfolio will perform during a steep market sell-off, one can get fairly close to the actual result by determining which particular index (OEX, perhaps) to use as a proxy for the portfolio and then determining the correct number of options to use as a portfolio hedge. Like other options, OEX offers leverage and predetermined risk. After all, the most the index option trader can lose is the premium he or she paid to hold the options, and the up side can be incredible.

It is important to note that equity index options have special tax consequences: 60% of any gain on the sale of the option is taxed as a long-term capital gain; the other 40% is taxed as short-term capital gain income.