Spy Options Trading!

Options Trading on the SPDR S&P 500 ETF (SPY)!

by Ian Harvey

May 17, 2018

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Definition.....

SPY (nicknamed "spiders") is an ETF (exchanged traded fund). When buying or selling the shares (on an exchange), the transaction price is very nearly that of SPY, but it may not be an exact match because Its market price is determined just like that of any other security - by an auction market.

The investment managers built a portfolio that seeks to provide investment results that (before expenses) mimic the price and yield performance of the S&P 500 Index. NOTE: The portfolio may only approximate that of the SPX index, but the results are "good enough" to suit the huge number of people who trade the shares.

SPY pays a quarterly dividend, and that is important because in-the-money call options are often exercised so that their owners can collect the dividend.

The SPDR S&P 500 ETF (SPY) has the most liquid options market of any ETF or even stock. The world's largest exchange-traded fund, with $261 billion in assets under management (AUM)... Bid/ask spreads on SPY options are often no more than a penny wide, minimizing transaction costs for those who want to hedge or speculate on the S&P 500.

Characteristics…..

  • SPY pays a dividend. Ex-dividend day is usually the 3rd Friday of Mar, Jun, Sep, Dec, and that corresponds with expiration day. It is important to be alert when trading in-the-money calls because most such calls are exercised for the dividend on expiration Friday. If you own such options, you cannot afford to lose the dividend and must know how to decide whether or not to exercise.
  • SPY options are American style and may be exercised at any time (after the trader buys them) before they expire.
  • SPY options cease trading at the close of business on expiration Friday.
  • SPY options are settled in shares.
  • One SPX option (same strike price and expiry) is worth approximately 10 x the value of one SPY option. This is very important. SPX trades near $1,200 and SPY trades near $120. Thus, one at-the SPX money call option is an option to buy $120,000 worth of underlying. One SPY option gives its owner the right to buy $12,000 worth of ETF shares. If you trade a lot of options at one time, it may pay to trade 5 SPX options rather than 50 SPY options. That plan saves significant dollars in commissions, but it does mean trading European options and trading an underlying with no dividend. That will not be suitable for every trader.

Trading SPY Options….

When trading an asset with such a wide variety of available strikes and expiration dates as SPY, the number of variables in constructing an options trade can be dizzying.

Looking at one-week returns on at-the-money SPY calls and puts, using hypothetical trades initiated at the close of trading on Friday and exited the following Friday (or the last day of the trading week, in the event of a holiday), and then breaking down the results to compare "traditional" monthly options returns against their weekly counterparts; to gauge whether one class outperformed the other -- and as such, looking at data back to 2011, which is the first full year of SPY weekly options data – the following was ascertained…..

SPY Option Calls.....

SPY call buying is a fairly dismal approach during quadruple witching week. The average at-the-money SPY call option return of a 20.53% loss is far worse than the average "any week" return of -7.76% -- despite the average SPY return of 0.24% for quadruple witching arriving right in line with the "anytime" weekly return of 0.22%.

And this divergence doesn't appear to be a function of pumped-up implied volatility (IV) heading into quad witching, either. The average IV since 2011 for SPY ATM calls was 16.9%; looking exclusively at quadruple witching weeks, it's only slightly higher at 17.1%.

SPY Option Puts.....

As for SPY put buying, it's a similar scenario to the call buying outcomes detailed above. The percentage of positive returns is uniformly slim -- ranging from a low of 16% during quad witching to a high of 23.35% in weeks outside of standard monthly options expiration -- which indicates a high probability of a losing trade.

That said, when SPY puts pay off, they pay off big. The average positive return for a profitable SPY put exceeds that of purchased calls during every week, ranging from an average positive gain of 116% during quad witching to nearly 182% (close to a triple) during monthly expiration weeks. For traders with high conviction that SPY will sell off during the course of any given week, a short-term options trade can be quite profitable.

Conclusion.....

Of course, the appropriate SPY options strategy will primarily depend upon the technical outlook for the ETF over the time frame of the trade. And that's where it's important to remember that, due to its outsized popularity among options traders, SPY is highly susceptible to the influence of heavy call and put open interest strikes -- particularly during monthly expiration, when open interest accumulations are often at their largest. Accordingly, any trader considering a short-term SPY trade would do well to include a careful analysis of the fund's relevant open interest configuration before opening a short-term options trade -- whether it's a purchased put, a sold call, or any alternative in between.


Best of Trading,
Ian Harvey
Director of Stock Options Made Easy


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