The big daddy of them all. Not the Super Bowl, but the S&P 500. Very few people know that the only way to actually trade the S&P 500 index is through SPX options.
We will get into all of that in just a second, but the truth is, the S&P 500 is THE index. Yes, it is one of the four major US indexes along with the Dow, the Nasdaq, and the Russel, but the S&P 500 is really the one that the institutions and professional traders watch all day every day.
How do these institutions and professional traders get exposure to the S&P 500 index? Through SPX options!
What is the S&P 500 Index?
Blah blah blah…it is the basket of 500 stocks that are diversified and blah blah blah.
People…is it THE index that everyone watches all day every day. That’s it. Which for some people should mean it is the index you will start to watch all day every day.
You might be saying, “okay, if it is the index I should care about it…how can I trade it?”.
How To Trade the S&P 500…Through SPX Options!
Here is something you didn’t know….
The SPX is cash settled. But what does that mean?
It means that all SPX options settle to cash. Whereas pretty much every single stock known to man that trades options settles to stock, how can it be that the SPX settled to cash?
Because there is no stock. The SPX is an index, not a stock. With zero volume traded in a day, that means there is no stock to buy or sell. Thus, there is no stock for options to settle to, so they settle straight to cash.
For a normal stock, when options expire, each option that is in the money expires to 100 shares of stock either long or short. On the next Monday morning, if you have an in the money option, you will have 100 shares of stock at the strike price of your option.
But for a cash settled index like the SPX, the settlement is to cash which means if you have an in the money option at expiration, the losses in cash will be taken from your account rather than you being assigned a certain amount of stock.
Have no fear, there are SPX options that allow for direct exposure to the index. And since this is the one index everyone looks at, we would expect some good things out of these bad boys…right?
Positives of the SPX Options
For starters, they have insane amounts of volume.
Which leads to an insane amount of notional value exchanged. Each option contract in the S&P 500 has a notional value of 1 times the price. This means that with 1,114,490 options contracts traded yesterday in the SPX, a grand total of $23720.60 * 1 * 1,114,490 = $26,436,371,494 of notional value exchanged hands. No, my math is not incorrect. Again, this makes it more believable that the index people care about is the S&P 500.
Clearly, institutions are making waves in here. Look at the volume and open interest at the at the money strikes.
We see 51,712 contracts traded at the $2375 strike yesterday for a grand total of $122,816,000 in notional value traded just at that strike. Insane.
On top of all of this, the SPX has more expiration cycles than any other tradeable asset. There are weekly, quarterly, and monthly options. There are so many expiration cycles in the S&P 500 index that there are no more than 2 days during the trading week in between expirations.
To make it even better, there are significant tax advantages to trading these types of index options. According to the IRS, the SPX falls under the 60/40 rules. This means that 60% of all gains on index options can be taxed as long term capital gains. What does this mean? Well for starters, if we buy a stock, we must hold it for a year in order to receive long term capital gains and pay 15% taxes towards those gains. But if we are fortunate enough to make money trading the S&P 500 index options, 60% of our gains do not require being held for one full year in order to get those benefits.
Let’s look at an example. Let’s say we are at a 40% tax rate and we make $1000 in the SPX options in March. Rather than owing $400 for tax purposes, we only owe $250 as we pay $90 on the first $600 and $160 on the rest. This creates an about a 37.5% savings come tax time.
To sum up the benefits of trading options in the SPX:
- Insane volume
- Insane open interest
- Insane notional value traded
- A lot of expiration cycles
- 37.5% tax advantage
Downside to Trading Options in the S&P 500
While there are a lot of positives to participating in trading in the S&P 500, there are some downsides. For starters, the markets are incredibly wide.
While there is a lot of liquidity here, the markets are too wide for most people to trade. At the money, we see options no less and $1 wide. The options here in the SPX only trade at $0.05 increments meaning anytime you make a trade in these options, you have to give up a multiple of $5. That kind of slippage is not suitable for anyone who does not have years of experience and a great deal of capital. No doubt we can get filled at any size we want, we will just have too much slippage and too much of an up-front loss.
The contracts are also enormous. Any who has traded SPX options before will tell you that when a trade goes against you even with one contract it really hurts. The SPX is 10 times the size of $SPY. Right now the $SPY is trading for $237.26 which means if we were to sell the $230 put, we would have to provide $4,600 in margin. Since the SPX is 10 times the size of $SPY, if we sold the $2300 put in the SPX, we would have to put up $46,000 in margin. That is larger than the entire account size of a lot of people I know.
To sum up the downside:
- Options markets are too wide
- There is too much slippage risk at order entry
- The contract size is too large
Are SPX Options Right for You?
We personally trade SPX options but we have been trading for years and have the experience and capital to do so. Only about a handful of our clients actually trade the SPX as well and all of those clients have a portfolio margin account..
For 99% of the people out there we do not recommend trading the SPX. However, we do recommend trading $SPY as it has the same amount of liquidity and interest, tighter markets, and is 1/10th of the size of the SPX.