A Proposal for Indexes for Traded Call Options

Abstract

IN RECENT YEARS OPTIONS exchanges were organized in the U.S.A. (Chicago Board Options Exchange, AMEX, PBW Exchange, Midwest Exchange, Pacific Exchange) and Canada (Montreal Options Exchange, Toronto Exchange). A new market for trading options on leading European stocks was recently organized by the Amsterdam stock Exchange. The growing interest in options as an investment medium is apparent from the ever-increasing volume of trading on the exchanges and the plans to open new trading floors. Whereas for the stock markets there exist a few well accepted indexes, there are no parallels for the options markets.' The procedures for the construction of stock indexes2 cannot be applied directly to options because options are shortlived assets. The purpose of this paper is to develop indexes for traded call options. In Section 2 the characteristics of call options and the factors affecting their values over time are described. In Section 3, a general overview is provided of the use of indexes in describing economic phenomena. Both the objectives and the limitations of indexes are discussed. These principles are applied to the specific case of an option index, and the possible objectives of such an index are discussed. Two performance options indexes are proposed, one for the call buyer, and the other for the covered call writer.3 These indexes summarize the behavior of two popular strategies for trading options.4 Moreover, the two indexes reflect the two facets of call options: leverage and insurance.5 The procedure of constructing the indexes is specified in Section 4 and evaluated in Section 5V6 Finally, in Section 6, the potential uses and misuses of the proposed indexes are summarized.