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Trading and Investment Terminology

Index Option

An index option can be defined as a financial derivative that provides the option contract holder the right, but not the obligation, to purchase or sell the value of an underlying index, for example, the Nifty 50, at the expressed exercise price on or prior to the option expiration date.

 

No real stocks are purchased or sold; index options are always settled in cash, and are normally European style options.

 

Index call and put options are the basic and mainstream instruments utilized by investors, traders and speculators to benefit on the overall direction of an underlying index while putting a small amount of money at risk.

 

The benefit potential for long index call options is boundless, while the risk is constrained to the premium sum paid for the option contract, regardless of the level of index at the time of expiry.

 

When talking about long index put options, the risk is additionally restricted to the premium paid, and the potential benefit is topped at the index level, less the premium paid, as the index can never go beneath zero.

 

Beyond potentially benefiting from general index level movements, index options can be utilized to diversify a portfolio when an investor is reluctant to invest directly in the index's underlying securities.

 

Index options can likewise be utilized in numerous manners to hedge specific risks in a portfolio.

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