What Are Non-Equity Options and How Do They Work?

Options trading isn’t limited to stocks. Many investors use non-equity options, contracts based on assets other than individual company shares. These instruments help hedge risk, speculate on price movements, or diversify portfolios beyond traditional equities.

Types of Underlying Assets

Non-equity options derive value from a range of assets beyond individual stocks, providing exposure to different financial sectors. The most common categories include index-based options, commodities, currencies, and interest rates.

Index-Based

Index options track market benchmarks such as the S&P 500, Nasdaq-100, and Russell 2000. Unlike stock options, which are tied to individual companies, these contracts reflect the performance of an entire market segment, allowing broad exposure without purchasing multiple stocks.

A key feature of index options is cash settlement, meaning no physical securities are exchanged at expiration. Instead, the payout is determined by the difference between the option’s strike price and the index’s final value. For example, if an S&P 500 call option has a strike price of 4,500 and the index settles at 4,600, the holder receives the 100-point difference multiplied by the contract’s standard multiplier of $100, resulting in a $10,000 payout.

These options are widely used for hedging against market downturns or speculating on economic trends. Institutional investors, such as pension and mutual funds, frequently use them to manage portfolio risk, particularly during volatility. The Chicago Board Options Exchange (CBOE) is a major platform for trading index options.

Commodity

Commodity options derive value from raw materials such as oil, gold, natural gas, and agricultural products like wheat and corn. These contracts help producers and manufacturers stabilize costs while offering speculators opportunities to profit from price fluctuations.

Unlike stock options, which are influenced by corporate performance, commodity options are driven by geopolitical events, weather, and macroeconomic factors. For example, a hurricane disrupting oil production can cause crude oil options prices to spike.

Commodity options can be physically settled or cash-settled, depending on the exchange and contract specifications. Physically settled contracts require delivery of the commodity upon expiration, making them more relevant for industry participants. Cash-settled contracts provide a payout based on the difference between the strike price and market price at expiration. The Chicago Mercantile Exchange (CME) is a leading marketplace for trading commodity options.

Currency

Currency options allow traders to hedge against foreign exchange fluctuations or speculate on currency movements. These contracts are commonly used by multinational corporations, importers, and exporters to manage exchange rate risks.

The underlying asset for these options can be a specific currency, such as the Euro or Japanese Yen, or a currency pair like EUR/USD. Exchange-traded currency options are available on platforms such as the CME, while over-the-counter (OTC) contracts offer more flexibility in contract terms.

Currency options are influenced by interest rate differentials, central bank policies, inflation reports, and geopolitical events. For instance, if the Federal Reserve raises interest rates while the European Central Bank keeps rates unchanged, the U.S. dollar may strengthen against the Euro, affecting EUR/USD options pricing.

Traders use strategies such as protective puts to limit losses in foreign investments or covered calls to generate income. Given the 24-hour nature of the forex market, these options are particularly useful for those dealing with international transactions.

Interest Rate

Interest rate options are tied to yields on financial instruments such as U.S. Treasury securities, Eurodollar deposits, and corporate bonds. These contracts help investors manage risks related to borrowing costs, bond portfolios, and monetary policy changes.

One of the most actively traded interest rate options is based on U.S. Treasury bond yields. Investors use these contracts to hedge against rising interest rates, which can reduce the value of fixed-income investments. For example, an investor holding long-term bonds who expects rates to rise may buy put options on Treasury futures to offset potential losses.

Interest rate options are influenced by Federal Reserve policy decisions, inflation expectations, and economic indicators such as employment reports and GDP growth. Since bond yields and prices move inversely, understanding these relationships is essential when trading these options. The CME and Intercontinental Exchange (ICE) are primary venues for trading interest rate options.

Key Characteristics

Non-equity options differ from stock options in contract specifications and market behavior. One major distinction is the standardized contract terms set by exchanges. While stock options typically cover 100 shares per contract, non-equity options vary based on the underlying asset. For example, index options often use a multiplier of 100, meaning a one-point move in the index results in a $100 change in contract value. Commodity options follow asset-specific contract sizes, such as 1,000 barrels for crude oil or 100 troy ounces for gold.

Expiration cycles also differ. Stock options generally follow monthly or weekly expiration schedules, whereas non-equity options may have quarterly, semi-annual, or yearly expirations. Index options often expire on the third Friday of the contract month, while interest rate and currency options may align with futures expiration dates.

Liquidity varies across non-equity options. Index options on major benchmarks like the S&P 500 tend to have deep liquidity and tight bid-ask spreads, while certain commodity or currency options may experience lower trading volume, leading to wider spreads and higher transaction costs.

Regulatory oversight also differs. Stock options fall under the jurisdiction of the Securities and Exchange Commission (SEC), whereas non-equity options—particularly those linked to commodities and interest rates—are regulated by the Commodity Futures Trading Commission (CFTC). This affects margin requirements, reporting obligations, and trading rules.

Pricing Considerations

The value of non-equity options is influenced by several factors beyond those affecting stock options. Implied volatility plays a major role, reflecting expectations of future price fluctuations. While stock options are affected by earnings reports and corporate news, non-equity options are driven by macroeconomic indicators, geopolitical events, and sector-specific developments.

Time decay, or theta, also affects pricing. As expiration nears, an option’s time value declines, but the rate of decay varies. Commodity and currency options may experience erratic time decay due to supply chain disruptions or central bank interventions. Index options tend to retain more time value because of their broad market exposure and liquidity.

Pricing models for non-equity options are often more complex than those for stock options. While the Black-Scholes model is commonly used for equity options, non-equity derivatives require specialized models. Interest rate options often use the Black-Derman-Toy or Heath-Jarrow-Morton models, which account for the term structure of interest rates. Commodity options may rely on stochastic models that factor in seasonality, storage costs, and convenience yields.

Margin Requirements

Trading non-equity options involves margin requirements that differ from those for stock options. Since these contracts derive value from diverse asset classes, margin calculations must account for specific risk factors. Regulatory bodies such as the CFTC and the Options Clearing Corporation (OCC) set guidelines that brokers use to determine capital requirements.

For exchange-traded options, initial margin is typically a percentage of the underlying asset’s notional value, adjusted for volatility and liquidity. Interest rate options often have lower margin requirements than commodity options due to the relative stability of fixed-income instruments. Conversely, natural gas or crude oil options require higher margin deposits due to extreme price swings.

Portfolio margining allows for reduced margin requirements when offsetting positions lower overall risk. Approved under SEC Rule 15c3-1a, this system considers net exposure across a portfolio rather than individual contracts, resulting in more capital-efficient trading. However, eligibility requires a minimum account balance, typically $100,000 or higher, depending on the broker.

Settlement Methods

Settlement methods for non-equity options vary based on the underlying asset. Unlike stock options, which involve the physical transfer of shares, non-equity options often follow different settlement mechanisms.

Cash settlement is common for index and interest rate options. Since these contracts do not represent ownership of a tangible asset, settlement is based on the difference between the option’s strike price and the final settlement value. An S&P 500 index option expiring in-the-money results in a cash credit or debit rather than a transfer of securities.

Physically settled options are more common in commodity and currency markets. These contracts require delivery of the underlying asset upon expiration, making them relevant for businesses involved in production, manufacturing, or international trade. Traders who do not wish to take physical delivery must close or roll their positions before expiration.

Tax Considerations

Tax treatment for non-equity options depends on the asset class, holding period, and whether the contract is exchange-traded or OTC.

Index options are generally classified as Section 1256 contracts under U.S. tax law, meaning they are subject to the 60/40 rule—60% of gains taxed at the long-term capital gains rate and 40% at the short-term rate.

Commodity and currency options may be taxed differently depending on classification. Exchange-traded futures options typically qualify for the 60/40 rule, while OTC currency options may be taxed as ordinary income. Frequent traders may also be subject to mark-to-market accounting under IRS Section 475. Given these complexities, consulting a tax professional is advisable.