A multi-index option is like setting up a race between two equity indices. Your return is based on the extent one of the indices outperforms the other other.
Think of it like a horse race. You're running Fast Rider against Pounding The Turf in a match race. Except...you don't bet on which horse will win. Instead, you bet on the distance between the horses at the end of the race. The greater the space between them at the finish, the bigger your payment.
You buy a multi-index option pairing the Global Cheese Index (or GCI) with the U.S. Post-Dairy Digestive Relief Medications Index (or PDDRM). The option you buy is based on a 2% spread.
You need one of the options to outperform the other by at least two percentage points in order to exercise it profitably. The GCI rises 5% before the option's expiration. Meanwhile, the PDDRM climbs 9%. The difference between the two indices was four percentage points...well above the 2% needed for your option. You cash in the option for a profit.
However, if the rise in the PDDRM had only been 6%, meaning the spread between the two indices only equaled one percentage point, your option would be worthless. You would have let it expire and eaten the cost of buying the option in the first place.
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Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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