Trade in Groups

Another index to understand.

Luckily, this one is easier to understand than it sounds.

Fixed Return Options (FROs) were recently launched on AMEX. FROs are defined here, but there is one critical point to understand. Traditional options (puts or calls) rely on the underlying stock’s price when the market closes on the expiration date.

The settlement index for FRO’s is determined differently than a standard option.

Whether or not you are ‘in’ or ‘out’ of the money on the expiration date when trading FROs depends on the Volume Weighted Average Price (VWAP) on the day the option expires. This is largely to avoid manipulation, since an investor can be ‘in’ or ‘out’ depending on a one-cent move in either direction.

The way VWAP is calculated is by adding up the dollar value of all trades on a stock for a give day and then dividing that sum buy the total number of shares traded.

Here is an example of VWAP:

Open: $24.75
High: $25.50
Low: $24.00
Close: $25.25

Total Shares Traded: 1,000,000
Total Value of Shares Traded: $24,990,000

Final VWAP: $24.99

The VWAP is simply used to ensure that all FRO contracts are settled fairly and are not subject to price manipulation.