Index versus stock options

You can buy an option on a single company, like Infosys, or on a whole index, like the Nifty 50 or Bank Nifty. On the option chain they look much the same, rows of strikes with calls and puts. But they differ in ways that matter, and the biggest difference shows up at expiry. It is also why many beginners are steered toward index options first.

Two families of option

Stock options are written on a single company. Their value tracks that one company, so a single-company event, a results announcement, a piece of news, a management change, can jolt them sharply.

Index options are written on an index, which is a basket of many companies. Their value tracks the whole basket, so no single company dominates. They move with the broad market rather than with one firm's fortunes, which makes them steadier in that particular sense.

The difference that bites: settlement

The most important difference appears at expiry, in how the option is settled.

Index options in India are cash-settled. At expiry nothing is delivered. The profit or loss is simply worked out from where the index closes and settled in cash. It is clean and simple.

Stock options in India are settled by physical delivery. If you hold a stock option that is in-the-money at expiry and let it go through, it results in the actual delivery of shares: the full lot changes hands. A call holder must take delivery, which means paying for the entire lot of shares, and a put holder or a seller must deliver them. That can be a large and unwelcome surprise if you expected a simple cash difference and instead face an obligation worth lakhs.

The difference in behaviour

The two also feel different to hold. Index options spread their risk across many companies, so they cannot be knocked out by one firm's bad day, and the major index options are usually very liquid, with tight spreads. Single-stock options carry the event risk of one company and vary widely in liquidity, so some are easy to trade and others are thin, with wide spreads to match.

For these reasons many beginners start with index options: cash settlement removes the delivery surprise, the popular index options are liquid, and the basket spreads risk. This is a common starting point, not a rule.

What to carry forward

There are two families of option: those on a single stock and those on an index. Index options follow a whole basket, are cash-settled, and tend to be liquid, which is why they are a common first step. Stock options follow one company, carry its event risk, and in India are settled by physical delivery at expiry, so an in-the-money stock option left to run can turn into an obligation to take or give a full lot of shares worth lakhs. Knowing which family you are trading, and what happens to it at expiry, is not optional.

That completes reading an option's value. The next part follows an option to the end of its life. It starts with what actually happens at and around expiry: exercise, assignment, and settlement.