What it means
Before the exchange opened, options on shares were arranged privately between dealers with no standard contract and no central clearing. The exchange standardised the terms, published prices and introduced a clearing house, which turned options from a specialist arrangement into something any investor could access through a broker.
The group has since expanded well beyond its original business. For a finance team the relevance is usually indirect: the prices it publishes feed the valuations used in accounting for share-based pay and in deciding what hedging costs.
The best known product associated with the exchange is its volatility index, built from the prices of short-dated options on a broad American share index. It is often called a fear gauge, because option prices rise when investors expect large moves, so a high reading means the market is paying up for protection.
Listed options follow standard conventions that catch people out. One equity option contract normally covers 100 shares, the quoted premium is per share, and the real cash cost is that premium multiplied by 100 and then by the number of contracts.
Finance staff outside trading desks meet the exchange most often when the business buys protection or values a share plan. Exchange prices are observable and independently published, which matters to auditors and to anyone who has to evidence that a valuation input was not invented internally.
In practice
Real-world examples.
Example
A finance director preparing share-based payment disclosures needs a volatility input for the valuation model. Rather than guess, she takes implied volatilities from exchange-listed options on three comparable listed companies and documents the source, which satisfies the auditor's request for an observable basis.
Example
A multi-asset fund manager uses the volatility index as an input to position sizing. When the index moves from the low teens into the thirties, the model cuts equity exposure automatically, because the same dollar position now carries far more expected movement.
Example
A newly promoted analyst quotes a hedge as costing $450 because the premium screen shows $4.50. The treasurer points out that each contract covers 100 shares, so one contract costs $450 and the 20 contracts needed to cover the exposure will cost $9,000.
Formula
Calculation
There is no formula for the exchange itself, but the cost of a listed option traded on it follows a fixed convention.
Cash cost = Premium per share x 100 shares per contract x Number of contracts
A treasurer buys 5 call option contracts quoted at a premium of $3.20 per share. The cash cost is $3.20 x 100 x 5 = $1,600, and those contracts give exposure to 500 shares. If commission is $0.65 per contract, the total outlay is $1,600 + $3.25 = $1,603.25, and if the options expire worthless that outlay is the entire loss.Case study
Seen in the real world.
Calderwood Industrials is an invented listed manufacturer used for this illustrative example. Its board had agreed to settle part of an acquisition in its own shares three months after signing, which left the seller exposed to a fall in the share price and the deal exposed to renegotiation.
The treasurer priced protection using exchange-listed put options on Calderwood's own sector index, since options on the company itself were too thinly traded to rely on. Covering 400,000 shares of equivalent exposure meant 4,000 contracts, and at a premium of $1.15 per share the cost came to $1.15 x 100 x 4,000 = $460,000.
In this fictional case the board rejected the full hedge as too expensive and bought half of it, accepting a known cost of $230,000 against an unknown renegotiation risk. The useful part of the exercise was that the exchange quote turned a vague worry into a priced choice the directors could minute.
Watch out
Common mistakes.
- Treating the quoted option premium as the cash cost of one contract, when it is a per-share price that must be multiplied by the 100 shares each contract covers.
- Reading a high volatility index level as a forecast that the market will fall, when it measures the expected size of movement in either direction.
- Using the old full name as though the group only ran an options market, when it also operates share, futures and currency venues.
Questions
People also ask.
When did listed share options start trading?
The first regulated exchange for them opened in 1973, which is why standardised contracts, published prices and central clearing are now taken for granted.
What does the volatility index actually measure?
The expected movement of a broad American share index over the coming month, derived from the prices of short-dated options rather than from anyone's forecast of direction.
Does a smaller company ever need exchange data?
Yes, most often for valuing share options granted to staff and for benchmarking what hedging would cost, because exchange prices are observable and easy to evidence to an auditor.
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