General Securities Representative (Series 7) Practice Exam

Which of the following is true about the trading of index options?

1. They can be exercised anytime before expiry

2. They are exclusively traded on the NYSE

3. They trade 24 hours a day

4. They settle based on the closing price of the index

The correct answer is: They settle based on the closing price of the index

The statement that index options settle based on the closing price of the index is accurate. Index options are a type of derivative that allows investors to speculate on or hedge against future movements in the underlying index. Unlike standard stock options, which can be exercised at any time during their life, index options typically settle through cash on expiration day based on the final value of the underlying index at the market close. This means that if you hold an index option through expiration, your profit or loss is determined by the settlement value, which is derived from the index's closing price. This structure also differentiates index options from equity options, which can be exercised at any time before expiration, allowing for more flexibility. While options on indices might be listed on various exchanges, including the Cboe and others, it's essential to recognize that they are not exclusively traded on any single exchange like the NYSE. Lastly, index options do not trade 24 hours a day; they have specific trading hours that are typically aligned with standard trading hours of major U.S. exchanges.