{"id":30967,"date":"2013-08-30T12:06:12","date_gmt":"2013-08-30T16:06:12","guid":{"rendered":"http:\/\/www.smbtraining.com\/blog\/?p=30967"},"modified":"2023-06-08T15:13:40","modified_gmt":"2023-06-08T19:13:40","slug":"trading-an-index-option-vs-a-stock-option-assessing-the-risk","status":"publish","type":"post","link":"https:\/\/www.smbtraining.com\/blog\/trading-an-index-option-vs-a-stock-option-assessing-the-risk","title":{"rendered":"Assessing Risk: Trading Index Options vs. Stock Options"},"content":{"rendered":"

How do we choose the perfect security for trading options?<\/p>\n

The evolution of options trading<\/a> strategies<\/a> will continue to expand but the one thing that will never change is the relationship between volatility and risk when assessing your next options trade. One of the considerations when trading options is what underlying vehicle you should trade. Should you trade options derived from an index like the S&P 500, Dow, Russell 2000 or Nasdaq 100? What about using ETFs or higher priced stocks like Autozone, Chipotle Mexican Grill or Booking Holdings?<\/p>\n

As usual the answer is not always so simple. There are pros and cons to each, so as an options trader it is important that you understand some of those differences before making your decision. Probably the single biggest difference is the diversification that you get with an index of 100, 500 or 2000 stocks compared to the risk associated with trading a single stock. What risk are we talking about? We\u2019re talking about a number of risks including:<\/p>\n

1)\u00a0\u00a0\u00a0\u00a0\u00a0 Event \/ News risk<\/p>\n

    \n
  1. \u00a0Announced and unannounced new product leaks<\/li>\n
  2. Product defects and recalls<\/li>\n
  3. Law suits from other companies and\/or countries<\/li>\n
  4. Merger and Acquisition activity<\/li>\n<\/ol>\n

    2)\u00a0\u00a0\u00a0\u00a0\u00a0 Earnings release \u00a0risk
    \n3)\u00a0\u00a0\u00a0\u00a0\u00a0 Competitive announcements<\/p>\n

    Any of the above could move the company stock dramatically and unexpectedly. When you own an index, you\u2019re still exposed to this risk, but at a much, much lower level. At the index or ETF level your risk is usually limited to market wide event risk, and just to name a few:<\/p>\n

    1)\u00a0\u00a0\u00a0\u00a0\u00a0 Geopolitical issues and threats
    \n2)\u00a0\u00a0\u00a0\u00a0\u00a0 Fed announcements
    \n3)\u00a0\u00a0\u00a0\u00a0\u00a0 Monthly employment reports, other governmentally and privately\u00a0 released economic reports<\/p>\n

    However, your individual stock will most likely move with the markets during these events so they are still<\/i> exposed to these same events. Therefore, the volatility associated with individual company risk is muted by the presence of other stocks in an index. While there are ETFs that mimic the big indices, there are also a lot of ETFs that focus on specific industries and niches. This would allow a trader to get exposure to oil for example but again, stay away from company-specific risk while exposing the trader to more risk than normal to industry-wide risk.<\/p>\n

    Another consideration worth looking into is the tax advantages associated with trading certain index options like the RUT, NDX and SPX under IRS section 1256. These options could have tax advantages over other options, as they are taxed at a rate of 60\/40 meaning 60% of gains or losses are considered long term holdings and 40% are taxed as short-term holdings regardless of how long you hold the option. Of course, it is important to consult with tax counsel or your accountant prior to making any options trading decisions based upon tax considerations as they are complex and subject to change.<\/p>\n

    While we have not covered \u00a0all of the \u00a0pros and cons of each, it is important to understand the differences in trading options with indexes, ETFs, and stocks before deciding what to trade.<\/p>\n

    Seth Freudberg and Michael Schwartz<\/p>\n

    no relevant positions<\/p>\n

    Risk Disclaimer<\/a><\/div>\n","protected":false},"excerpt":{"rendered":"

    How do we choose the perfect security for trading options? The evolution of options trading strategies will continue to expand but the one thing that will never change is the relationship between volatility and risk when assessing your next options trade. One of the considerations when trading options is what underlying vehicle you should trade. Should you trade options derived … Read More<\/a><\/p>\n","protected":false},"author":1037,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[3327,3326,1951,3325,4683,1259,3324,1965,3328],"class_list":["post-30967","post","type-post","status-publish","format-standard","hentry","category-general-comments-2","tag-call-option","tag-how-to-trade-options","tag-option-strategies","tag-option-trading-strategies","tag-options","tag-options-trading","tag-options-trading-101","tag-options-trading-strategies","tag-put-option","no-post-thumbnail"],"yoast_head":"\nIndex Option vs. Stock Option: Risk Assessment | SMB Training<\/title>\n<meta name=\"description\" content=\"SMB Training shares insights on assessing risk when trading index options versus stock options.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" 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