I have had special requests to write about the topic of Index Options. I know that Index Options are rumored to be too risky, too advanced, etc but in reality Index Options are the same as stock options. You can buy them, sell them, and track them exactly the same. Here are a couple core differences between a typical stock option and index option...

Index options are cash settled. This means that there is no underlying stock to deliver or take delivery of. Instead you receive the cash value of the Index at settlement. This is only if you decide to exercise.

Index options are expensive! Since many indices are values in the triple or quadruple range, this means the options will be expensive. For example take a look at options on the Nasdaq (NDX) Front month ATM'zzz.....

NDY AF Bid 38.00 X Ask 38.40 (Delayed Quote)

Yikes! Purchasing a contract is like paying your mortgage. These contracts are very expensive, and require very strict risk management principles, unless your comfortable going all in on one of these.

There is a substantial amount of leverage trading Index options, in fact this is the biggest leverage you can get out of options, and this is why they are so heavilly traded. Some of the more popular vehicles would be the SPX, NDX, DJX, RUT...and other industry specific indices like OIX, XAU, SOX, etc. Or perhaps you don't want that much leverage? Try the Mini's! MNX, XSP, RMN, or DJX (not relly a mini, but a smaller value than the underlying index). This gives you the capability to track the underlying index, not at the same pace, but at a better pace than an ETF option (QQQQ, DIA, SPY, etc.).

I guess the next best item to cover would be strategy. I find these products bode real well with spread traders. For me personally as a directional trader, I have traded directionally with index options, but only when it is obvious to do so. For example, in a trending market like we have experienced over the last several months this is a great time to trade index options. However, I would prefer just trading the futures contract instead.

Looking at that option premium, and how expensive it is, we could say at such a high premium it would make more sense to be a seller (as long as you do not expect big directional movements!). Like I said earlier, these are great vehicles for high probability spread trades. Verticals, Butterflies, Iron Condors, etc. Occasionally I will trade spreads on the indicies, even though I hate to admit it, but normally only in a bearish environment where I can trade call spreads. Since the market tends to correct, I prefer to sell calls than puts. Plus, calls are priced higher than puts which makes more sense.

The market is one of the hardest vehicles to predict directional movement in, so I suggest that if you are going to trade an Index, do it with a non-directional trade like some of the spreads I mentioned. I also would suggest starting small. Try a mini index first, and work your way up. For example, if the market starts to break support levels, lets try an index spread as a group activity.

Anyone out there title themselves as an Index Option trader? Any insights you would like to contribute or strategies you find that work well?