Option contracts, in general, give the holder the right (but not the obligation) to buy or sell a certain underlying asset.
You might have the option to buy 100 shares of NFLX at $400, expiring in June. Or you might have the option to sell 100 barrels of oil at $70, expiring in July.
An index option applies this concept to an index, rather than an individual stock or other asset. So...you might acquire an option to buy the value of the S&P 500.
These contracts allow investors to bet on general market movements (letting the S&P 500 stand in for the overall stock market, for instance) or target particular segments of the market, as tracked by other indexes. They also provide a way to hedge risk elsewhere in an investor's portfolio.
Related or Semi-related Video
Finance: What is a greenshoe option?15 Views
finance a la shmoop what is a greenshoe option. oh you should be so lucky
green shoes on leprechauns and investment bankers are such a good thing. [leprechaun smiles]
why? well because when there is so much excess money laying all over the floor
your shoes turn green from the bills as you take whatever money you can carry
and run. that's how the name happened anyway a greenshoe option is a deal term
that an investment bank negotiates for in an IPO they run. and that IPO remember
is an initial public offering of stock. this can apply also to secondary
offerings and other kinds of offerings but we're focused on an IPO here as a
green shoe lives. if that IPO is marketed so well and there is so much demand for
shares in the company from the public that the bank believes it can raise the
IPO price and sell more shares to the public then that IPO was a huge winner.
the bank will exercise its greenshoe option and instead of selling 30 million [money falls from the sky]
shares of Chucky LARM calm to the public at 12 bucks a share well it'll bring the
company public at 15 bucks a share and sell 40 million shares. the math? it
raises 600 million bucks in the latter green shoe field option versus 360
million bucks in the former. the green shoe is the extra 10 million shares that
the bank can sell and get commission on while doing so. and if you think about
that world as a 5% kind of Commission world well the banks go from 18 million
in total Commission's to 30 million. yeah nice freakin bump especially when
there's a basic fixed cost of maybe 10 million dollars in either case. so you
make a lot more profit on the 30 million story here yeah? all right and having
more shares out there trading is a good thing for the company because its shares
are then more liquid. it's easier to buy and sell larger blocks of stock and the [stocks being sold in a graphic]
big institutions like that. they tend to then take a lot more
interest in the stock and usually that leads to higher stock prices down the
line. and all that liquidity or movement shares trading back and forth well
that's more Commission dollars in the future for the bank. so check your shoes
if they're green well you're either in the money or you should really get Rover
to the vet. [green poo on a wood floor]
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