Trading options on the S&P 500 index is a popular way to profit from the index. There are many methods traders use in this index, but two of the most common ways are trading options on SPX or SPY. The main difference between the two is that SPX options are based on the index, while SPY options are based on an exchange-traded fund (ETF) that tracks the index.
What is the difference between SPX and SPY options?
Distributions: Distributions are typically not paid to option holders. However, SPY pays distributions every quarter. This is crucial because if you’re trading in-the-money call options, you can exercise them to collect the distributions. To do this, you need to exercise your options on SPY before the ex-dividend date or own the shares and write a call (known as a covered call).
Trading style: There are two different styles of trading, European and American. European options can only be exercised on the expiration date, while American options can be exercised at any time before the expiration date.
Expiration date: SPX options that expire on the third Friday stop trading the day before the third Friday (the third Thursday). On the third Friday, the settlement price is determined based on the opening prices of the index’s stocks. This price is the closing price for the expiration cycle. SPY options stop trading at the end of the third Friday.
Settlement: SPY options are settled in shares. When you exercise your options, you will buy (or sell) shares of the ETF. Cash is used to settle SPX options, so if you exercise them and you are in the money, you will receive cash in your brokerage account.
Value: An SPX option is also roughly 10 times the value of an SPY option. For example, on April 9, 2020, SPX closed at 2789.82 points, and SPY closed at $278.20. It is important to understand that one SPX option with the same strike price and expiration date is worth approximately 10 times the value of one SPY option. Therefore, each SPX point was worth $100.
Which is better for you?
Assets within SPX do not trade, so there are no shares available to buy or sell. Options are written so that traders can bet on the movements of the S&P 500 prices. SPX acts as a theoretical index price calculated as if it were a real index.
SPX options settle in cash because futures and options contracts are traded on the index. SPY options settle in shares because stocks are traded on the exchange. Therefore, options contracts are written so that you receive a portion of shares when exercising the option.
Which option is best for you depends on your strategy and goals. If you want to have a share of the stocks for holding or trading back, SPY may be the better option. If you prefer trading for value and receiving cash in your account, then SPX is an excellent choice.
SPY options bring some additional risks. For example, on the Monday following expiration, you will own shares. You will owe the price of those shares at the time of expiration, not the price on Monday. So if the share price drops on Monday, you will pay more than they are worth that day. However, if the price rises, you will pay less than the current market price.
Conclusion
The main differences between SPY and SPX options are that they are either American or European style, and SPY options are based on an exchange-traded fund while SPX options are based on the index prices themselves. You should understand the difference that makes it easier to exercise your options. Additionally, the difference in value (and settlement) emphasizes the importance of how much you have to spend on options.
If
If you have more capital at your disposal and do not need the distributions, SPX may be a good option. On the other hand, SPY may be a better option if you are short on funds and can make use of the distributions.
Frequently Asked Questions (FAQs)
What is options trading? Options are contracts that give the owner the right to buy or sell a security at a specified price during a specified time period. Options trading is the process of trading the right to buy or sell those securities without the risk of price changes. As the name suggests, the owner has the right to buy or sell at a specified price during the life of the contract, but there is no obligation to do so.
How can you trade SPX and SPY options? Like any other day trading, you will need to open a brokerage account to start trading SPX and SPY options. Look for a broker that specializes in options trading and allows you to practice trading before putting real money at stake.
Source: https://www.thebalancemoney.com/spx-options-vs-spy-options-2536632
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