500 Part V: Index Options and Futures 
of IBM, one might figure that capitalization-weighted indices that contained that 
stock would also be showing somewhat unusual price changes in the same direction 
that IBM is moving. A price-weighted index that contained IBM would, of course, 
also be affected by IBM's price change, but not extraordinarily so since IBM would 
have far less weight in the price-weighted index. 
SECTORS 
Sector is a term used to refer to an index of stocks in which all the stocks are mem­
bers of the same industry group. Examples of groups on which sectors have been cre­
ated - and on which options have traded - are computers and technology, interna­
tional oils, domestic oils, gold, transportation, airlines, and gaming and hotels. These 
indices are computed in the same ways as described above - either price-weighted 
or capitalization-weighted. They generally consist of fewer stocks than their major 
counterparts, however. Most sectors are comprised of between 20 and 30 stocks, 
since that is about all of the stocks in any one specific industry group. The large 
indices are usually referred to as "broad-based" indices, as opposed to the smaller 
sectors which are often referred to as "narrow-based" indices. 
Options trade on these sectors. The intent of these options is to allow portfolio 
managers -who often are group-oriented- to be able to hedge off parts of their port­
folio by industry group. The options on these sectors are usually cash-based options. 
Strategies will be discussed later, but there is not much difference in strategy 
between broad-based or narrow-based index options. One difference is that broad­
based option writers receive more favorable margin treatment ( that is, they are 
required to put up less collateral) than narrow-based option writers. 
CASH-BASED OPTIONS 
Now that the reader is familiar with indices, let us look at the most popular type of 
listed index option, the cash-based option. 
Cash-based options do not have any physical entity underlying the option con­
tract. Rather, if the option is exercised or assigned, the settlement is done with cash 
only - there is no equity involved. This type of option is generally issued on an index, 
such as the S&P 500, for which it would be virtually impossible to actually deliver the 
underlying securities in case of assignment or exercise. 
Since many investors feel that it is easier to predict the market's movement 
rather than that of an individual stock, the cash-based index option has become very 
popular. Other indices that underlie cash-based option contracts are the New York 
Stock Exchange Index, the S&P 500 Index, the S&P 100 Index (OEX - an index