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Understanding differences of SPY vs. SPX

Chris McKhann (chris.mckhann@optionmonster.com)

When it comes to the battle of SPY versus SPX, the first may have more volume, but the second has more value--which leads to a deeper discussion of index and ETF options.

The SPDR S&P 500 (NYSEArca:SPY) exchange-traded fund's contracts are the most widely traded on the equity option exchanges, seeing more than 1.2 million change hands each session. Next on the list is Citigroup with about half of that volume, then the SPX S&P 500 index options not far behind.

While the numbers are impressive, recent media attention has brought to light some misconceptions about the place of ETF and index options. For while the SPY's contracts trade far more than the SPX's, the notional size of the SPX volume eclipses that in the SPY. Because the SPX options are 10 times the size of the SPY's, there is clearly a lot more money tied up in index options.

Using this as a springboard, I thought we would take a look at some of the important differences between index and ETF options in general.

To start with, ETF options have a single underlying but index options do not. The SPY options have the SPY fund as their underlying, while the SPX options are based on the S&P 500--in other words, the 500 stocks that compose the index. So you can't trade the underlying to hedge the options, but there are clearly proxies that can used.

For this reason, index options are "cash-settled," as opposed to settled in the underlying shares. So if you end up with in-the-money SPX call options at expiration, you end up with cash--as opposed to being long SPY stock, as you would if you were long SPY calls.

Most index options are also European-style contracts, with the notable exception of the OEX S&P 100 index options. This means that traders cannot exercise their options before expiration, as they can with American-style contracts. (Most equity options are American- style, so they can be xercised at any time before expiration.)

Index options--especially the SPX, VIX, RUT, and OEX options--are still largely traded in the physical pits, but this continues to shift to electronic trading at an ever-rising pace. And on electronic platforms the spreads can seem quite wide: In one recent example, while the SPY May 132 calls had a $2.30/$2.31 bid/ask spread, the May 132 SPX calls had a $19.80/$22.80 bid/ask.

This difference highlights several more important points, including the fact that index options often have odd expirations. The SPX contracts have a Friday morning settlement, while the VIX options settle on a Wednesday morning.

In addition, the SPY and the SPX don't always trade in perfect unison. When the SPY closed on April 13 at $131.46, the SPX finished at $1314.41. Note their differences in the last hour of that session on the chart below, which shows the SPY in blue and the SPX in magenta.

What's important to remember is that you can almost always get inside of that bid/ask spread, especially if you are not trading in huge size. But given that the SPX options are 10 times the size of the SPY's, if you are trading a lot of SPY options, you may very well be better off turning to the SPX.

Finally, there can be tax benefits to trading index options. Although I am not a tax expert, the last time I checked, index options are treated as 1256 contracts--like futures--which are taxed differently from regular equity options

Most retail traders bypass index options for a variety of reasons, but they are definitely worth consideration depending on your strategies and size.

(A version of this article appeared in optionMONSTER's Open Order newsletter of April 13. Chart courtesy of tradeMONSTER .)