Final answer:
The maximum risk for an index option writer is unlimited because there is no cap to how much the underlying index can increase (for a call) or decrease (for a put). Index options usually settle on the third Friday of the expiration month. The option writer must pay the buyer if the option is exercised and in-the-money.
Step-by-step explanation:
The maximum risk for an index option writer is potentially unlimited. When one writes an index option, they are selling the rights to the buyer to either buy (in the case of a call option) or sell (in the case of a put option) the underlying index at a specified price up until the expiration date. If the market moves in the opposite direction to the position taken, the losses can continue to grow without a cap, as there is no limit to how high (or low) an index can go.
Index settlement usually occurs on the third Friday of the expiration month for monthly options, and it is typically based on a special opening quotation of the index on the expiration day. This event is known as exercise settlement, and it can vary depending on the specific index option and market.
In the case of exercise, the responsibility for paying the in-the-money amount falls on the option seller. If the option is exercised, the seller must pay the buyer the difference between the strike price and the settlement price of the underlying index multiplied by the option's contract multiplier.