Both experienced and novice investors appreciate the efficiency of trading in index options. For one thing, doing so helps investors diversify their portfolios quickly. In addition, it exposes shareholders to a broad range of assets. The truth is, there are scores, perhaps hundreds, of reliable indexes with which to trade. Yet some indexes are able to, like the cream, rise to the top.
The S&P 500 (short for Standard & Poor's 500) is a stock market index that monitors the value of the 500 largest and highly capitalized companies traded on U.S. stock markets. Trading in the S&P 500 (SPX) can be often lucrative.
Stock Options, in Brief
A stock option is actually a right to buy or to sell a stock. It is the power to control the stock for as long as the option remains in place. A put option conveys the power to sell stock whereas a call option renders the power to purchase it.
Ways to Trade SPX Options
Perhaps the simplest way to trade is to buy a call or put on the index. If an investor is optimistic about the index going up, she will purchase a call option, the right to buy, unconditionally. Should a downward trajectory look likely (i.e. stock prices are in decline), a put option, or right to sell, on the index is preferable to focusing on individual stocks that are dragging the index down. There are more costs to the latter strategy.
SPX options are traded European style, meaning that traders can only exercise options on the date that they actually expire. Expiring on Friday (or the end of business on Thursday before the third Friday), these options are assigned their settlement price according to the opening price of each stock in the index.
SPX trades, whether purchases or sales, are settled in cash, contrasted with other index options like SPY that settle in shares. Those who make money on a trade will find it in their brokerage accounts. So, investors who trade for cash value find an attractive vehicle in the SPX.
Read More: Choose the Right ETFs for Your Portfolio
S&P 500 Criteria for Companies
Those who trade SPX options are looking at assets – stocks – that are on the level with those selected by the S&P 500 Index.
Among the major stock indexes, the S&P leans heavily toward companies with the highest market capitalization. This quality is determined by multiplying the present stock price by the total number of outstanding shares. Investors have easy access to the market caps of both the index and its constituent companies since they are routinely published in myriad business publications.
S&P 500 assigns weight to each company by dividing the total index market cap by the market cap of the company. Furthermore, the S&P formulates market caps using free-floating shares exclusively as opposed to locked-in shares available to executives, promoters and the government. This gives confidence to investors who trade SPX stocks.
Read More: List of Stocks in the S&P 500 Financial Index
Practical Info to Trade SPX Options
It all begins with opening an account with a broker, preferably one who regularly deals in SPX options, such as Cboe. Large brokerages are a safe bet, but make sure to confirm that they do trade SPX options in advance.
An advantage to this is that these brokers often have resources online with which people can affect trades without risking any money before jumping in with both feet. The broker can also provide software with which the client can monitor the value of S&P 500 assets in real time. This is useful assistance.
Read More: The Best Ways to Buy Stocks Online
- Brokers who specialize in options trading provide a large amount of online educational materials for trading and using their systems. Study these resources before you start trading.
- Focus on the options contracts with the most trading activity to start. Actively traded options have the best pricing and quickest order fill.
- Options trading is a high-risk venture --- it's possible to lose 100 percent or more of your invested amount in a short period of time. The Securities and Exchange Commission (SEC) stresses the need for self-education before attempting any options trading program.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.