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What is index trading, how to trade, and does it work?

  • by Money Life Research
What is index trading, how to trade, and does it work?

 

What is index trading?

When a group of stocks is traded which make up an index, they are called Index Trading. Every section of the stock market is measured in terms of value and is called an index. The basis for Index computation is from the prices of selected stocks. The Stock Market is growing and gaining importance in our economy so are the different Index names gaining combined importance.

The stock traders speculate on the price of an asset and transact in the stock exchange. Two parties enter into a contract to exchange the difference in the value of an asset, which was taken from the time the contract is started, to the time the contract is ended. Indices trading facilitates exposure to the entire sector at once and accessing the different shares is not required.

How does Index Trading work?

A group of stocks is weighted based on some indexes or indices. The indices can be weighted by a couple of factors. The valuation of the company, the price of the stock, available capital, preferences for short-term or long-term positions in stocks are a few factors. The performance of different companies is measured to understand the position of a stock index.

When a particular stock market index is bought and sold it is defined as Index Trading. The price of the index will usually rise or fall. The investors and traders will speculate on the rising or falling price of the index. Based on their speculations, decisions are made to buy or sell the index. Index refers to the execution of a group of stocks. The investors shall be involved in buying the average execution of the group of stocks and not buying the actual underlying stock. The value of the index shall increase when the price of the shares for any particular company within the index increases. Correspondingly, when the price of the shares for any particular company within the index decreases, the value of the index shall also decrease.

What are the strategies used when trading index options?

There are a couple of strategies available when trading index options.

  •  Purchasing a put or call on the index is the most common strategy. Through this strategy, the transactions are made depending on the level of the index. Purchases made when the index is going up are called a call and purchases made when the index is going down are called a put.
  • Bull call spreads strategy: Through this strategy, the purchases are made when the price is low and selling is done when the price has increased.
  • Bear put spreads strategy: Through this strategy, the purchases are made when the price is high and selling is done when the price has decreased. This strategy is of less use but is advantageous to traders as their capital remains saved and risk is at low levels.
  • Selling covered calls Strategy: Through this strategy, call options are sold against contracts that are already purchased in the stock index market by the investor.

Final Words-

Understanding the strategies and how index trading works is important for any investor to make a living out of index options trading as they give investors the chance to make profits by selling underlying stock indices.


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