Legal Definitions - Chicago Board Options Exchange

Chicago Board Options Exchange (CBOE)

The Chicago Board Options Exchange (CBOE) is the leading organized marketplace in the United States specifically designed for trading financial contracts known as options. It provides a regulated and transparent environment where investors can buy and sell these contracts, which give the holder the right, but not the obligation, to buy or sell an underlying asset (like a stock or an index) at a predetermined price on or before a specific date.

Here are some examples illustrating the role of the CBOE:

• Example 1: Individual Investor Speculation

  An individual investor, Sarah, believes that shares of "Tech Innovations Inc." are likely to increase in value over the next three months. Instead of buying the shares outright, she decides to purchase call options on Tech Innovations Inc. through her brokerage account. Her broker routes this order to the CBOE, where it is matched with a seller. If Tech Innovations Inc.'s stock price rises as Sarah predicted, her options become more valuable, allowing her to profit with a smaller initial investment than buying the actual shares.

  This example demonstrates how the CBOE serves as the central venue for individual investors to execute their options trading strategies, whether for speculation or other purposes, by providing the necessary infrastructure to connect buyers and sellers.

• Example 2: Institutional Portfolio Hedging

  A large pension fund manages a diversified portfolio that includes a substantial holding in various blue-chip stocks. Concerned about potential short-term market volatility leading up to a major economic announcement, the fund manager decides to hedge against a possible downturn without selling off their stock positions. They instruct their traders to buy put options on the S&P 500 index. These put options, traded on the CBOE, would increase in value if the S&P 500 index falls, offsetting potential losses in their stock portfolio.

  Here, the CBOE facilitates sophisticated risk management for institutional investors, allowing them to protect large portfolios against adverse market movements using standardized options contracts.

• Example 3: Market Volatility Indicator

  Financial news reports frequently reference the "VIX Index," often called the "fear gauge," which measures the market's expectation of future volatility. The VIX Index is calculated in real-time using the prices of S&P 500 index options traded on the CBOE. When the VIX rises, it indicates that investors are anticipating greater market uncertainty, often leading to increased demand for protective options.

  This illustrates the CBOE's foundational role in providing the raw data (option prices) that underpin critical market indicators like the VIX, offering insights into overall market sentiment and risk perception for investors worldwide.