Once again, Iโd like to thank Tiger for awarding the weekly top predictions for QQQ and SPY today ๐
Today, I wish to share which option do I prefer to trade: SPY or SPX. Before that, we need to under the background for each of them first.
Same Same But Different?
Though nearly identical in performance, there is an ocean of difference between the SPDRยฎ S&P 500ยฎ ETF Trust (SPY) and S&P 500ยฎ Index Options (SPX). It is absolutely vital you understand the different nature of these two products before you place your first options trade.
Both are fruits right? ๐ค
The SPX, or the Standard & Poorโs 500 Index, is a stock index that is comprised of the 500 largest U.S. publicly traded companies by market capitalization, or the stock price multiplied by the number of shares it has outstanding.
The SPY is an exchange-traded fund (ETF) that tracks the performance of the S&P 500. An ETF is a marketable security that acts like an index fund but is tradable like a common stock on a stock exchange.
SPX options are European-style options and can only be exercised on the expiration date. SPY options are American-style options and can be exercised anytime between the time of purchase and the expiration date.
SPX options do not pay dividends whereas SPY options do. SPY options dividends are paid quarterly, usually at the options expiration in March, June, September, and December.
SPX options are settled in cash since the underlying asset itself is not traded. SPY options are settled in shares since the underlying asset itself is traded on exchanges.
All SPX options, except for those that expire on the 3rd Friday of the month, expire at the close of business on expiration Friday. SPX options that expire on the 3rd Friday stop trading the day before the 3rd Friday. All SPY options expire at the close of business on expiration Friday.
An SPX option with the same strike price and expiration date as an SPY option is approximately 10 times the value of an SPY option. For example, if an SPX option was trading at $1,000, then an SPY option would trade for $100.
The two key differences between SPY vs. SPX options are that they are either American or European style, and SPY options are on an ETF while SPX options are on the prices of the index itself. You should understand the difference this makes for exercising your options. Additionally, the difference in value (and settlement) makes how much capital you have to buy the options important.
If you have more capital to spare and don't require dividends, SPX might be a good choice. On the other hand, SPY might be a better choice if you're a bit short on funds and can use the dividends.
For tax reasons, SPX offers many benefits over SPY. Additionally, SPX is cash-settled, so there is no assignment risk. Most professional traders prefer to trade SPX for these reasons. SPY, however, offers tighter strike prices and more liquid markets.
Option trades summary
โ ๏ธ Trading Tips: One key advantage in taking SPY contracts is that we can buy more contracts with a lower cost. A good practice is to add more contracts and multiple stages to size up when the trades are working for you.
Similarly when taking profits, we can scale out by selling say half the contracts at resistance. If there is breakout, exit with another 30% at next level and let the remainder 20% run.
Adjust the stop loss higher or use the trailing stop so that even if the price retraces, we can still lock in higher profits. Most importantly, we are green and never have to see red ever again.
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