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Lesson 6. Stock Derivatives > Options - Pg. 33

Stock Derivatives Plain English 33 Stock index options are options to buy or sell stock whose price represents the value of the entire market at a predetermined price, regardless of the actual value of the market. Stock indexes work on the same principle as the farmer's market example. They also facilitate trading for those investors whose trades are based on the markets rather than individual stocks. Let's say, for example, that you believe the stock index will rise $1 a day for the next two weeks. Because the index is an average, some of the listed stocks will gain value and some will lose value, but you believe that overall the market average will rise. You could buy one share of every stock on the index if you were so inclined. Be warned that indexes are usually composed of hundreds and even thousands of stocks, so this idea is pretty impractical. The bookkeeping alone would be a nightmare, and you would need zillions of dollars to buy at least one share of everything on the index as well as pay all the service charges. Instead, you could buy a stock index put and wait for the index to go up. Since you believe the stock index will go down, you would buy a stock index call to achieve the same result. American Depository Receipts (ADRs) American Depository Receipts (ADRs) are one of my favorites, because they work the exact op- posite of most derivatives. Instead of making things more complicated, ADRs simplify things for the average investor. ADRs are stocks in pools that comprise foreign stocks. For example, let's say you've heard of this great company in Mexico, Widgeto Incorporado. You really want to invest in that company, as you've just read they've invented a new widget made out of adobe. You're convinced the value of Widgeto Incorporado stock is about to go through the roof. You could open up a brokerage account in Mexico and go through the normal procedures to buy Widgeto Incorporado. But, in all honesty, the paperwork involved would be horrendous. Being a