I have always favored the SPDR S&P 500 ETF (NYSEARCA:SPY) when trading options. It is a very liquid and the Bid/Ask spreads seem to be reasonable. Many option traders choose to trade options directly on the SPX Index (S&P 500). The CBOE recently introduced “PM Settled” for the SPX monthly options with a new ticker - SPXpm. I thought this would be a good opportunity to take a second look at SPX and see if and where it’s a better fit. I’ll try and be as concise as possible in this article. I urge readers to visit the CBOE website to obtain more detail.
First, the one part of SPX Options that always interested me was that it was CASH SETTLED. This meant that no shares ever changed hands and at expiry the difference between the settlement price and the strike price was directly added or subtracted from the account balance. This had at least two advantages over SPY:
- Shares could not be assigned before expiry
- Avoidance of being “nickel and dimed” by closing out positions in-the-money that would otherwise be assigned at expiry. In this regard, SPX was a “cleaner” avenue to travel.
The problem was that SPX Monthly Options were “AM” settled. The settlement value was calculated on the opening on Friday morning. This meant that trading stopped on Thursday’s close instead of Friday’s close.
This doesn’t seem like such a big deal. After all, what difference does one day make? In this case, a BIG DIFFERENCE. If the settlement value was as of Thursday’s close, then it would replicate the SPY, only one day sooner. But this is not the case. The settlement value is at the open on Friday and, as we all know, this can be higher or lower than Thursday’s close. This always presented problems for me. I just don’t like my ability to trade to stop and the price to pay or receive to go on without any way to counter, if necessary.
Well, by introducing the SPXpm, and settling the contracts as of Friday’s close, the CBOE has sought to replicate the same timing as exists with SPY.
Let’s start by looking at some differences between SPX and SPY. SPX is an index, whereas SPY is an ETF. That means that SPX value is determined directly by the value of the underlying stocks comprising the S&P 500. SPY, on the other hand, is “influenced” by these very same stocks, but its price is set by buyers and sellers of the ETF.
Also of great importance is that SPY is approximately 1/10th of the price of SPX. That means you can trade as little as one option contract with SPY representing $12,600 in value. One option contract for SPX would control $126,000 in value. In this regard, SPX loses flexibility.
SPX accounts for dividends from the underlying stocks as they are received and SPY accumulates them and makes a quarterly distribution. These factors mean that SPX and SPY will be close in value and move in tandem, but not exactly.
Readers who have followed my articles know that I often sell weekly options on the SPY as part of a calendar strategy. For about a year the weekly options on SPX (SPXw) were “PM” settled. Now, I could have bought options on SPY and sold weekly options on SPXw, but they don’t quite match up and I avoided this complexity. Now, with “PM” settled monthly SPX options I can take a second look.
Let me start by looking at the upcoming expiration of the November monthly options at the end of this week.
SPY is trading at $126.66 and SPX at $1,263.85. So, we can see right away, they aren’t an exact ten to one fit, but are about 2% away from this. As a result I will get a close, but not exact fit by looking at the $126 SPY strike and the $1,260 SPX strike. When the expiration is this near I would only be selling an option, so I’ll restrict this comparison to the Bid prices of the option.
First, let’s look at PUT options. The SPY bid price on the $126 strike is $1.45. The SPXpm $1,260 strike is $15.30. If I sold TEN SPYs I would earn $1,450 and selling ONE SPXpm would generate $1,530. A slight advantage to SPX. But, if SPY and SPX fell below their respective strikes and went “in-the-money” a bigger advantage would ascribe to SPXpm. I would have to buy-to-close the SPY option to avoid assignment at a cost of at least $120 whereas the SPXpm cash settles. All-in-all, the SPXpm earns an advantage of $80 to $200. This is 5% to 15% more premium than SPY when selling near-term puts.
Now, I’ll look at selling call options at the $126 strike (slightly in-the-money). The SPY $126 strike Bid price is $2.11 and the SPXpm $1,260 bid price is $18.60. This would seem to favor the SPY but it needs a little adjustment. The SPY is 66 cents “in-the-money” so the extrinsic value is $1.45 ($2.11 minus .66). Ten sold option contracts net $1,450 extrinsic value. The SPXpm is $3.85 “in-the-money” so the extrinsic value is $14.75 ($18.60 minus $3.85). One contract credits $1,475. Seems like a tie. Not quite, if the options remain “in-the-money” at expiration the CASH SETTLED SPXpm will save up to $120 in closing costs, or about 8% of the premium.
Now, let me look at the January 2012 expiration. In this case I could be either buying or selling the option, so let me look at both sides. Once again, I’ll use the $126 and $1,260 strikes.
First, BUYING PUTS: The SPY costs $5.79 and the SPXpm costs $58.70. At first glance the edge goes slightly to the SPY, but it is probably greater than the initial look. I tend to close out long option positions and usually roll them out a month before expiration. The BID price for SPY is $5.72 and the BID price for SPXpm is $55.66. So, if I wanted to close this position out before expiry, the “bid/ask spread” is only seven cents for SPY (about 1.2%) but a WHOPPING $3.04 (about 5.5%) for the SPXpm. This cost is significant enough to deter SPXpm.
What about SELLING PUTS: The bid on SPY is $5.72 and the bid on SPXpm is $55.66. Ten SPY credit $5,720 and one SPXpm credits $5,566. This clearly favors the SPY by more than enough to compensate for any costs associated with closing the position at expiry if it were in-the-money.
Rather than go into the particulars of buying or selling long dated CALLS, let me just say that the dynamics mimic the results in the PUT example above.
What do I conclude from all of this? First, the “P.M.” settled SPXpm could serve as a better trading vehicle than SPY for near-term expirations. I would certainly consider it when selling “in-the-money” options.
However, the SPY is a clear winner when looking at longer durations. SPY also has an advantage in flexibility due to its lower trading price.
I would probably use SPXpm or its weekly counterpart, SPXw, when selling cash secured puts or naked calls with very near-term expirations. But, I would not pair it with long-dated SPXpm options in strategies such as calendar spreads.
The most attractive results seem to be obtained by using long-dated SPY options and selling weekly SPX options in calendar spreads. Of course you need to be willing to undertake this added complexity and the position size issues. This could also create some margin issues unless your broker will pair SPX with SPY. The CBOE has a circular that seems to indicate this is possible, but I have no direct experience with this.
Disclosure: I buy and sell options on SPX and SPY.