SPX (SM) vs. SPY Advantage Series- Part II The SPX Size Advantage September 18, 2013 Presented by Marty Kearney @MartyKearney
Disclosures Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, by calling 1-888-OPTIONS, or at www.theocc.com. The information in this presentation is provided solely for general education and information purposes. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Multiple-leg strategies involve multiple commission charges. No statement within the presentation should be construed as a recommendation to buy or sell a security or to provide investment advice. CBOE, Chicago Board Options Exchange, CBOE Volatility Index, OEX, VIX and XEO are registered trademarks and Execute Success, Quarterlys, SKEW, SPX, SPXpm, The Options Institute, Weeklys and XSP are service marks of Chicago Board Options Exchange, Incorporated (CBOE). S&P, S&P100 and S&P 500 are trademarks of Standard & Poor s Financial Services, LLC and have been licensed for use by CBOE. S&P does not sponsor, endorse, sell, or promote any S&P index-based investment product. All other trademarks and service marks are the property of their respective owners. Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, SPXpm and XSP are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations. Copyright 2013 CBOE. All rights reserved. CBOE OPTIONS INSTITUTE 2
Presentation Outline Review: The Mechanics of Index Options Size of SPX versus SPY Option Contract Tax Considerations Example Long Bullish Call Spread Smaller SPX the XSP SPX Option Pricing Summary Additional Resources CBOE OPTIONS INSTITUTE 3
Mechanics of Index Options SPX options function much like SPY (ETF) options Both calls and puts are available for trading There are several major differences: SPX options settle in cash, not in shares SPX options are European style Covered in Part I yesterday Size of the contract A potential tax benefit exists for index option traders CBOE OPTIONS INSTITUTE 4
The Cash Settlement Process Example: SPX is 1638.53 at expiration Cash Value of a 1600 Call? SPX Value 1638.53 Less Strike Price 1600 Difference 38.53 x Multiplier x $100 Cash from Seller to Buyer $3853.00 CBOE OPTIONS INSTITUTE 5
Index Options - SPX Ticker Symbol SPX Underlying S&P 500 Stock Index Multiplier $100 Exercise Style European Settlement AM Full Contract Size 10 x SPY Tax Treatment 60-40 (Broad-based index) CBOE OPTIONS INSTITUTE 6
Potential Tax Advantage of Index Options
Index Options Potential Tax Advantage ETF Options Are treated like stock options* Broad Based Index Options Receive 60-40 Tax Treatment** 1256 Contracts *Consult your tax advisor **According to Taxes and Investing, published by The Options Industry Council, available from http://www.cboe.com/learncenter/rcgeneral.asp Note: Under Section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, SPXpm and XSP, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations. CBOE OPTIONS INSTITUTE 8
60-40 Tax Treatment - Example You bought an SPX option Monday at $5.00. Two days later you sell the option at $9.00. Taxes are due on the $400 gain. CBOE OPTIONS INSTITUTE 9
60-40 Tax Treatment 1256 Contracts: All Profits treated as 60% long term / 40% short term regardless of holding period Reported on Form 6781 and Schedule D Year end prices become cost basis for the new year CBOE OPTIONS INSTITUTE 10
Index Options Broad Based Index Options include: S&P 100 OEX, XEO S&P 500 SPX, SPXpm, XSP* CBOE Volatility Index - VIX * XSP is the 1/10 size Mini-SPX option contract, also based on the Standard & Poor's 500 Stock Index. XSP has most of the same features of SPX: Broad-Based, European Style, 1256 contract. It is the same size as SPY. CBOE OPTIONS INSTITUTE 11
SPX Size Matters
SPX Comparison to SPY Contract Comparison SPY is the SPDR S&P 500 ETF which represents ownership in a portfolio of stocks that replicates the S&P 500 Index. The underlying pricing for both SPX and SPY options is the S&P 500 Index CBOE OPTIONS INSTITUTE 13
SPX Comparison to SPY Size Comparison S&P 500 at 1640.00 1 SPY Option = $164 x 100 = $16,400 1 SPX Option = 1640.00 x $100 = $164,000 To control the same amount of market value, 10 SPY contracts need to be traded for each SPX contract CBOE OPTIONS INSTITUTE 14
SPX Comparison to SPY Contract Comparison Summary S&P 500 at 1640.00 SPY SPX Underlying Value 164.00 1640.00 Contract Underlying 100 Shares $100.00 American / European American Style European Style AM / PM Style PM Both Available Settlement Buy / Sell Shares Pay / Receive Cash CBOE OPTIONS INSTITUTE 15
Long SPX Debit Spread
Trading Example S&P 500 quoted at 1664.00 We have a bullish outlook over the next three weeks and expect market to rally +2% to 1700.00 by quarter end (September 30 th ). SPXQ options expire on last day of June, September, December and March CBOE OPTIONS INSTITUTE 17
Long SPX Call Spread Example S&P 500 at 1664.00 To trade this positive outlook for the S&P 500 we decide to do the following: Buy 1 SPXQ (9/30/13) 1670 Call at 17.80 Sell 1 SPXQ (9/30/13) 1700 Call at 6.00 11.80 db. CBOE OPTIONS INSTITUTE 18
Long SPX Call Spread S&P 500 at 1664.00 Long SPXQ 1670-1700 Call Spread at $11.80 Breakeven: 1681.80 (1670 plus $11.80) Risk: $11.80 Potential gain: $18.20 Difference in strikes ($30) less $11.80 premium paid = 18.20 Prices as of 9/6/13 Excludes transaction costs CBOE OPTIONS INSTITUTE 19
Debit Spread Long 1 SPX 9/30 1670 Call @ 17.80 Short 1 SPX 9/30 1700 Call @ 6.00 20.00 15.00 10.00 5.00 0.00 (5.00) (10.00) Current Price 1664 1650 1661 1672 1683 1694 1705 1670 & 1700 Calls Expire OTM 1670 Call ITM 1700 Call OTM 1670 & 1700 Calls Both ITM (15.00) (20.00) CBOE OPTIONS INSTITUTE 20
Long SPX Bull Call Vertical Spread Long 1 SPXQ 1670 1700 Call Spread at $11.80 Payoff Table SPX at Expiration 1640 1650 1660 1670 1680 1681.80 1690 1700 1710 SPXQ 1670-1700 Spread Call Premium Profit / Loss 0.00 (11.80) (11.80) 0.00 (11.80) (11.80) 0.00 (11.80) (11.80) 0.00 (11.80) (11.80) 10.00 (11.80) (1.80) 11.80 (11.80) - 0-20.00 (11.80) 8.20 30.00 (11.80) 18.20 30.00 (11.80) 18.20 CBOE OPTIONS INSTITUTE 21
More SPX & SPY Differences SPY commission 10 contracts in and out SPX commission 1 contracts in and out Tax consequences on gain: SPX 1256 (60/40) SPY tax status uncertain SPY position turns into SPY shares if not closed, SPX settle in cash CBOE OPTIONS INSTITUTE 22
SPX & SPY Settlement SPX at 1,664 goes to 1,694 at expiration The SPX 1670 1700 spread now worth $2,400 SPX spread settles in cash, $2,400 A comparable SPY position (if not closed out before expiration) turns into 1,000 SPY shares CBOE OPTIONS INSTITUTE 23
SPX Option Pricing
SPX Option Pricing SPX October 1690 Call is $12.00 bid - $12.50 offer SPY October 169 Call is $ 1.20 bid - $ 1.25 offer Which option is more expensive? That s easy.. CBOE OPTIONS INSTITUTE 25
SPX Option Pricing SPX options - usually more expensive than SPY? Yes, but they re 10 X the size An SPX October 1690 Call might show: $12.00 bid offered at $12.50 A SPY October 169 Call could be: $1.20 bid, offered at $1.25 One would need to buy or sell 10 X the number of contracts in SPY to equal each SPX contract CBOE OPTIONS INSTITUTE 26
Option Pricing Comparing SPX October 1700 Call is $3.00 bid $3.30 offer SPY October 170 Call is $0.30 bid - $0.32 offer Why wouldn t they be the same? SPY is AM settlement, SPX is PM SPY volume greater (SPX notional value larger) Quantities bid / offered on SPY could be small. Same can be seen with XSP. Marketmakers hedge in a variety of ways. Try limit orders. CBOE OPTIONS INSTITUTE 27
Why SPX Options? Larger notional size potentially lower commissions (10 to 1 ratio) Convenience of cash settled options versus physical delivery of shares No potential early exercise issues with SPX Preferred choice of sophisticated institutional traders Potential tax benefit CBOE OPTIONS INSTITUTE 28
Summary SPX Options are an excellent method of gaining exposure to the S&P 500 Index SPX Index options are eligible for 60/40 tax treatment* Three part forecast needed for option trades: underlying / time / implied volatility Spreads offer unique trade-offs www.cboe.com/spx *Note: Under Section 1256 of the Tax Code, profit and loss on transactions in certain exchangetraded options, including SPX, SPXpm and XSP, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations. CBOE OPTIONS INSTITUTE 29
Additional Resources At www.cboe.com go to the Index Micro-Site http://www.cboe.com/micro/indexsites.aspx This site includes information on SPX, XSP, SPXPM, as well as Dow Jones Indexes, Russell Indexes, NASDAQ Indexes, VIX, Skew and Custom Indexes as well as Weekly and Quarterly options. CBOE OPTIONS INSTITUTE 30
Archived Webinars For additional webinars on SPX or other Index products including VIX & credit spreads, go to: Credit Spreads - Weeklys(SM) Iron Condors - http://accordent.powerstream.net/008/00124/presentations/cboe20130509 The Holy Grail of Trading Iron Condors: http://accordent.powerstream.net/008/00124/presentations/ds20130514 CBOE OPTIONS INSTITUTE 31
Additional Webinars VIX and SPX - First Quarter VIX Trading Review - http://accordent.powerstream.net/008/00124/presentations/cboe20130409 Trading Index Options: Popular Strategies for Today s Markets - http://accordent.powerstream.net/008/00124/presentations/cboe20130319 SPX vs SPY - http://accordent.powerstream.net/008/00124/presentations/20130226cboe CBOE OPTIONS INSTITUTE 32
Upcoming Seminars New Trends in Trading VIX Chicago, IL or Online September 28, 2013 Options Profits, Option Pit and the Options Institute at CBOE are teaming up for a full day of education covering what is new in the world of trading options, futures and exchange-traded products on VIX and other volatility related markets and how VIX products can be utilized in this current low volatility environment. Simply the Basics Chicago, IL October 30, 2013 Simply the Basics is a half-day seminar led by CBOE Options Institute instructors, Peter Lusk and Russell Rhoads, that helps you understand the basic concepts of options -- such as what are calls and puts, what are the factors that influence the price of options contracts and what makes values change? Options Initiative- Level 1 Beginner Chicago, IL or Online December 2 & 3, 2013 This 2-day classroom experience plus 10 hours of distance coaching will introduce you to the basics of options and the basics of market timing, stock selection and risk management. For more information or to register go to: www.cboe.com/seminars CBOE OPTIONS INSTITUTE 33
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