Trading Options on an Index


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[responsivevoice_button rate=”0.9″ pitch=”0.5″ volume=”0.8″ voice=”US English Female” buttontext=”Play”]Play Trading an index is a different game. The best known and most traded index is SPX. You can’t buy shares of the SPX, but you can buy and sell options. And many, many people do. Since the SPX doesn’t have shares, options on it cannot be exercised, which means they cannot be assigned. At expiration settlement is made in cash. Consider what that means when you sell a vertical spread. In a normally settled American option that is settled by the exercise of ITM contracts at expiration, you may find yourself in the uncomfortable situation where the short leg of a vertical spread is ITM while the long leg is OTM and expiring worthless. This means that the spread will now longer have a defined risk. See an earlier post for a detailed example of this risk.

Strikes on SPX are $5 wide, and option contracts are expensive; however, bid-ask ATM spreads typically run less than 5%. APX options with their high volume and volatility provide many opportunities for traders who follow the S&P 500. The SPX offers contracts that expire every day Monday through Friday.

A less pricey choice for trading an S&P 500 index is XSP, which trades at price 10% of XPS with dollar wide strikes. It has lower volumes than SPX, but narrow spreads. It offers contracts that expire on Monday, Wednesday, and Friday every week. NDX and RUT are similar cash-settled European style options that serve the Nasdaq and Russell indices.

A similar trading choice is to trade /ES, the E-mini S&P 500 futures. Trading options on futures has additional twists that I’ll discuss in later posts.

Key Take-away: Trading options on indices differs significantly from trading options on equities or EFTs. Be sure you understand the differences.

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