Index Option

An index option is an options contract whose underlying is a stock market index rather than a single company’s shares. Instead of betting on one stock, you’re trading a view on the whole basket of stocks in the index. Like any option, it can be a call option, which gains when the index rises, or a put option, which gains when it falls.

In India, the main index options are traded on NSE on the Nifty 50, Bank Nifty, FinNifty, Nifty Midcap Select and Nifty Next 50, and on BSE on the Sensex and Bankex. The weekly contracts, Nifty 50 on NSE and Sensex on BSE, usually see the most trading.

How index options work in India

• Cash settlement. You can’t deliver an index, so index options are cash-settled. At expiry, in-the-money options are paid their intrinsic value in cash, based on the index’s closing value that day. Out-of-the-money options expire worthless.
• European style. Index options can only be exercised at expiry, not before. You can still buy or sell them at any time before then. See European option.
• Expiry. NSE index options expire on Tuesdays and BSE index options on Thursdays. Each exchange has one index with weekly options, and the rest have monthly contracts only. See expiry date for the full schedule.
• Lot size. Each index has its own lot size, set by the exchange and revised from time to time. Check the current lot size before you trade.
• Premium. You buy or sell the option at its premium, quoted per unit of the index and multiplied by the lot size.

Worked example: buying an index call and put

Say an index is at 20,000 and its lot size is 50 (hypothetical numbers).

Buying a call. You buy the 20,000 call at a premium of ₹150, paying 150 × 50 = ₹7,500.

• If the index closes at 20,300 on expiry, the call settles at 300 points, so ₹15,000 is credited to your account in cash. Your profit is ₹15,000 – ₹7,500 = ₹7,500.
• If the index closes at 19,900, the call expires worthless and you lose the ₹7,500 premium.

Buying a put. You buy the 20,000 put at a premium of ₹140, paying ₹7,000.

• If the index closes at 19,800, the put settles at 200 points, so ₹10,000 is credited. Your profit is ₹10,000 – ₹7,000 = ₹3,000.

In both cases, no shares change hands. Only the cash difference is settled.

Index options vs stock options

Many traders start with index options because there’s no risk of a surprise share delivery at expiry and no single company’s results can blow up the trade.

Worked example: hedging a portfolio with index puts

Index puts are a common way to protect a share portfolio against a market fall. Say you hold a ₹10,00,000 portfolio that tends to move in line with the index, which is at 20,000 with a lot size of 50 (hypothetical numbers).

• One lot covers 20,000 × 50 = ₹10,00,000 of index exposure, so one lot of puts matches the portfolio.
• You buy one lot of the 20,000 put at ₹300, paying ₹15,000.

If the index falls 10% to 18,000 by expiry:

• Your portfolio falls by about ₹1,00,000.
• The put settles at 2,000 points, paying 2,000 × 50 = ₹1,00,000.
• Your net loss is roughly the ₹15,000 premium, instead of ₹1,00,000.

If the market rises instead, the put expires worthless and the ₹15,000 is the cost of the insurance. This is the index version of a protective put.

If your portfolio tends to move more than the index, it needs more cover. A portfolio that typically moves 1.5 times as much as the index has ₹15,00,000 of index exposure, so it needs about 1.5 lots, rounded to whole lots.

How traders use index options

• Directional trades. Buying calls or puts to trade a view on the overall market with limited risk.
• Hedging. Buying index puts to protect a stock portfolio, as in the example above.
• Earning premium. Selling options, usually as part of a defined-risk spread, to collect time decay.
• Trading volatility. Straddles, strangles and iron condors are bets on how much the index will move, not which way. Implied volatility and India VIX show how big a move the market is pricing in.
• Reading sentiment. Index option data feeds widely watched indicators such as the put-call ratio and max pain.

Risks to keep in mind

• Time decay works against buyers. An index option loses time value every day through theta, and fastest close to expiry. Most out-of-the-money options expire worthless.
• Expiry-day swings. On expiry day, at-the-money premiums can swing sharply on small index moves because of gamma risk.
• Selling options carries large risk. A naked option sold without a hedge can lose far more than the premium collected in a sharp move.
• Costs add up. STT, brokerage and exchange charges are paid on every trade, which matters for frequent traders.

To see live premiums, open interest and every strike for the Nifty, open Stolo’s Nifty option chain, or analyse index options across strikes and expiries with Stolo’s option chain analysis.