Option trading is not restricted to individual stocks. The large commodity market is an option market that deals in all manner of commodities such as grain or cattle. There is also another type of investment known as index option trading.
An index is a listing of a number of different stocks that share something in common, and it represents the composite value of all of them. An example is the Dow Jones Industrial Average which represents the value of the 30 largest and most widely held industrial stocks on the New York Stock Exchange. The Standard and Poor’s 500 is another index that represents 500 different stocks. These two well known indices are used frequently to gauge the progress of the economy and the general health of the stock market. They are familiar to most people, even those with little or no interest in the market, as they are widely quoted on news broadcasts.
They represent just two of a large number. There are broad based ones that reflect a wide range of widely different stocks, and there are ones that are very specific to a certain group. As the Dow Jones tracks industrial stocks, another index called The Morgan Stanley Biotech Index tracks 36 different stocks of companies engaged in biotech research. An index can list companies with similar products, and even similar management styles. There are also a wide variety of foreign indices that reflect the composite value of foreign stocks.
An index may also be classified as to how it is weighted. Some regard every stock equally, and a price fluctuation in any stock in the index will have an impact of the index price no matter how large that individual stock’s share of the index might be. Other indices “weight” the index based on the size of the company. In other words, small companies that experience even a large price change will not have as much impact on the index as a small change in one of the largest companies.
Index option trading is popular in part because the risk is considered to be lower than with individual stock. This is partly because the index, representing a variety of stocks, is less likely to be subjected to the same adverse pressures that may cause an individual company to experience a very rapid decline in its value. The index is seen as much easier to subject to trend analysis, and this makes it a popular part of most Mutual Fund portfolios.
There is another classification of indices that might be of interest to investors with certain social and environmental sensitivities. They are known generally as Ethical Indices as list stocks that satisfy certain criteria in their business operation. An example of one such index is the Wilderhill Clean Energy Index. Sadly, in the current market there is no direct connection between environmental sensitivity and profit, but with an Ethical Index, you can at least feel good about yourself while you make money, or even feel somewhat good if your investment turns out the opposite way.
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