I was impulsive this morning and went ahead and wrote a call spread on SPX to start getting some short exposure…THEN I was thinking… you don’t even know how this instrument works!
I get that SPX tracks (?) the S&P500 but I am confused exactly how. I have these questions:
the general quote for the value of the S&P500… is that based directly on the value of the basket of stocks in the index, or is the value based on the SPX instrument (or futures /ES)
If SPX is a traded instrument, how does it track the given value of the S&P so well.
bottom line… what is the relationship between SPX, /ES, S&P 500, and the basket of stocks that make up the index.??
You probably wrote a call directly against the index. Careful, taking a short position after an index has taken a 5% hit is an easy way to get burned. People have this tendency to BUY HIGH SELL LOW. I’ve learned a lot about tempering my trigger finger by either forcing myself to wait to the end of a week to make a trade and just watching my emotions through this year. I first started by only trading in my 401k, which requires 1M holding periods per investment. So I was forced to discipline my moves and really consider my trades and use discipline.
Thats a good way to start trading BS. I tend to use the bulk of my portfolio for multi year investments. Have about 10% or so I play around with for short term stuff. Any time I use those ST funds and get a nice chunk of a return in a few days I always feel that temptation to increase my trading funds as opposed to investing funds. Not sure I understand the retail investor response to sell into panic and buy into strength, but I tend to be a contrarian. Was buying all day today.
SPX is the index itself. SP Y is the ETF that *tracks* the index. SPY can have tracking error. SPX might have some kind of intraday wierdness to it because there may be a small lag between trades in the index components and how those numbers shows up in the index itself, but SPX actually *is* the index so cannot have any tracking error by definition.
There is a multiplier for changing SPX points into dollar figure. $250 sticks in my mind, but after a google search, I see that $250 per point is for futures, $100 per point is for options, and $50 per point for e-mini futures (basically the same as a future, but with a smaller multiplier for smaller accounts).
EDIT: I think you might be asking about things like how can the SPX change value in futures trading when the components on the exchange aren’t trading. I believe what happens here is that what’s reported in after hours trading are implied prices based on what people are willing to pay for to go long or short a future after hours and what SPX price would actually be consistent with that. Then at the end of the day, margin accounts are trued up to what the index actually is. So there may be some intraday tracking error of a sort but it’s probably smaller than the transaction costs, except on a really volatile day.
@Bchad… so when I watch SPX in real time I am watching the actual fluctuations in the basket of stocks, not the supply/ demand price discovery set by those trading SPX? I understand there is a difference between SPX and /ES. /ES is the market for futures contracts to buy SPX at various values, yes? @BS… it must seem silly to take a short position on a day like today. However, it is about a quarter of the position I intended to eventually take. I wanted to make a start in event things actually get worse! We probably will rally at some point, but I am comfortable with my strike, margin at risk, and ability to “roll out of trouble”. I also have a small long position using a short call spread on the 3x geared short S&P ETF. On that one, decay is on my side as an edge. Anyway… bearish to neutral on the market.
Yes, during trading hours, SPX is the actual index which is supposed to change in proportion to the the market value of the public float of the 500 companies composing the index.
When a trade happens on an index component, that presumably changes the price. With modern computers, presumably what they do is they compute some volume adjusted average for the trades on all index components over the last few minutes and use the shares outstanding (which don’t change very often) to compute the total market value. So if I trade a share of AAPL and it lowers the price by a penny or two, I’m not sure how quickly it actually makes it into the SPX price you see on your screen. However, since even the largest company is only about 5% of the index (I think it is still AAPL, but maybe it’s XOM or GE or something), that means that small changes are unlikely to be a major issue, since if AAPL went bankrupt at noon, a huge event like that would only push the SPX down 5%, so a trade that pushes the price up or down a few bucks is unlikely to have a huge effect on the SPX value (though there might be psychological feedback effects on other stocks if AAPL really did go bankrupt suddenly).
When the market closes, SPX doesn’t change, but the futures market may still be open. So futures prices can deviate from the last close and so CNBC and other data sources talk about “fair value for the index” which basically uses the arbitrage pricing for futures to back out the implied SPX price that would be consistent with where futures are trading. Since futures only converge to the index at expiration, there can be some fluctuation before expiry, especially when the main market is closed, though it still can’t deviate too much, since margin gets trued up on a daily basis if needed.
^thanks, that makes complete sence. Someone mistakenly confused me by saying the buyers of SPX set the price and then the weights in the basket of stocks are made to fit that??? (like an ETF) After thinking about what I know about indexes, that makes absolutely NO sence
Well, people do trade the basis between futures and index cash values. However, the implied funding value is derived from the futures market (supply and demand). It’s not completely arbitrage free, since everyone has different cost of funds and the market can experience pressure under some circumstances, but unless you are a highly specialized market participant, you probably can’t exploit this.
In regards to your actual call spread position on SPX, there are some things you should know:
Settlement is different than most equity options. For the monthly options, the value will be determined on Friday AM instead of PM, based on the open of the market. Weeklys are PM as normal.
Quoted bid/ask spread appear to be very illiquid. This is because SPX only trades at 1 exchange. The actual liquidity though is very high, so place trades at the midpoint and you’ll generally get fills (especially for spreads).
SPX: Higher leverage than SPY, but for spreads you can adjust for this in many ways if you want lower leverage. SPX also has the advantage of avoiding the divididend risk that something like SPY has.
What exactly does that mean if settlement is Friday AM? Does it mean if I need to roll, do it no later than the _ Thursday _ before expiration? My spread is on a monthly so thanks for the heads up!
I did noticed the liquidity was great. I got filled immediately on my limit order …and at a solid credit (Well, having the VIX at 23-24 dosen’t hurt either). I also brought up a couple dummy orders to see what kind of credit/ debit I am looking at to roll it out a month…not bad. Although, if I need to roll, that would mean the VIX will be down, so I may be looking at different numbers at that point.
actually… side quesion: Would implied volatility effect the credit on a spread since both your long and short calls are changing by the same percent?
It doesn’t make sense in this context, but if what they are describing is some kind of arbitrage mechanism to take advantage of what Ohai was talking about, then I could see an algorithm taking an implied price from SPX futures and then building a basket of stocks to replicate the index, a bit like the ETF mechanism. Perhaps that is what they were talking about.
Also, sometimes people say SPX when they mean SPY or vice versa. So there’s the possibility that this was a mis-spoken thing.
Finally, if you are trying to replicate SPX options with a basket of underlying stocks, then there probably would be a lot of underwater basket weaving to build a replicating portfolio. However, I’m not sure if anyone would do that, because I would think the transactions costs of building a replicating portfolio of 500 stocks would be prohibitive. My understanding is that SPX options are replicated by market makers by dynamic hedging of futures contracts, but maybe that’s not true.
No, this guy was saying the actual weights in the index itself were reset to match match the SPX value traders were setting. I now see that it is the other way around. The basket of stocks sets the price of SPX and then you can buy the index at the current value. The buying/ selling pressure of SPX does not effect it’s value… only the buying /selling pressure of the stocks in the index effects the value.
I would be very curious to know how the option prices for SPX are set. This is what I meant by I was being “impulsive”. I should know how the price is set on an instrument if I am going to trade it. Perhaps the individual stocks in the index need not be considered. I have not studied black-scholes yet, but I assume it factors in variables such as strike, time to expiration, risk free rate of return, and implied volatility. In that case, general market risk only need to be considered… individual stocks could be kept out of it.
Yes, you will need to roll on or before Thursday. Liquidity tightens up late in the day as well, especially if your strikes are not near the money. If you remain in the position on Friday, it will be cash settled (usually around 1030-1100 am CT once all stocks are trading). Overnight moves which cause the market to open away from Thursday close are the biggest risk since you can’t trade on Friday.
I will assume you sold an OTM spread. Volatility will hurt your position. Here’s why… There is something called the Volatility Smile. It basically means that volatility is lowest when you are right at the money. i.e. you know the most about the price right where it is right now, and if you go up in price or down, volatility is higher. Looks like a smile or a x^2 chart, w/ prices on the bottom. (google it for the picture). Anyways, the effect that volatility has on the option price (Vega) is highest at the money. Again, volatility is lowest at the money, but changes in volatility effect the prices the most at that spot. Therefore, if you sell a spread (let’s say a 1950/2000 call spread on spx w/ market at 1930), the 1950 call is going to be effected more by volatility than the 2000. Volatility causes option prices to rise. Since you sold the 1950, bought the 2000, the 1950 will rise higher than the 2000 if the Vol rises. This will therefore hurt your credit spread.
Let me know if that makes sense. My bolding of words seems somewhat sporadic, but whatever.
^ you are awsome! yes that makes sense… also, will have a minimal effect on my spread as I used only the next strike up. Should be minimal damage due to divergence between the two strikes ( in this example, would be sold 1950 and bought 1955)
Something else to note given the AM settle is that it is not uncommon for at least one of the 500 stocks to not open on time. Yes, it can affect whether your trade is profitable or not. Look into it. The cboe has excellent explanations for all their products and very clearly states how value is determined in all cases.
Not that it is any of my business, but wouldn’t you want to learn everything you can before you gamble? Everything mentioned in this thread is available at the click of a mouse. Remember this is a zero sum game. You have to be better, or luckier, than those on the other side and overcome a spread, it matters no matter how small.
Of course you can do what you feel is best, but I would strongly advise based on this conversation against investing through derivatives unless you are independently wealthy (unlike me). You’re taking on a lot of risk, somewhat naively and impulsive investing never ends well. You would probably be better served just using ETF’s and observing the derivatives for awhile. If you really wanted to be diligent about it, you could start with X amount of money in a spreadsheet and record your “trades” for six months with no redos. Try to account for transaction costs too, those can be big in those markets.
I mean, assuming you did a 1950/1955 spread, you probably got around 2.50. 1 contract, that’s only $250 of risk. (5-2.50)*100.
Opitions absolutely can be very risky and leveraged, but considering what you traded (narrow credit spread), you’re probably fine. I do completely agree though… learn as much as you can. There are many things with options trading that no one ever thinks of or considers until they get reamed.
You learn by doing… you can’t do dervatives on paper. You never really know were you would have been filled or how liquidity would have effected your trade. I could paper trade, but fills are sketchy comparied to live trading. You learn by doing. I am only learning, which is why I picked a concervative trade, with a reasonable strike and my max loss is already defined at $350. I Have already considered my damage control plan if I am surprised by the market. Give me a little more credit! (I appreciate the concern though)
