What is a ‘Multi Index Option’
A Multi index option is an outperformance option where the payoff is based on the Relative Performance of two indexes or other assets. The payoff from these exotic derivatives is determined by the change in the percentage price performance of one index or asset over another. They mainly trade in the over-the-counter market.
BREAKING DOWN ‘Multi Index Option’
Multi index options are spread options where the payoff depends on a change in relative value rather than market direction. They are sometimes used by investors to hedge risks or to speculate on the relative performance of stock indexes, different issuers in the bond markets, or exchange rates – especially when there is no cross rate available to trade. They can also be relatively low cost, compared to vanilla index options.
For example, consider a multi index option on the relative performance of the S&P 500 versus Canada’s TSX Composite, over a year. If the option has a strike price of 5% — the threshold between the option paying off or expiring worthless — then, if the S&P 500 has declined 2% but the TSX has declined 9% after a year, the option will have a positive payoff of 2% because the S&P 500 has outperformed the TSX by 7% points. If the S&P 500 outperforms by less than 5%, the option will expire worthless.
Multi index options are typically, but not required to be, European options, which can only be exercised at maturity, and are settled in cash.
The post Multi Index Option appeared first on NewsWorld.