The market offers a host of different financial instruments, each of which have their advantages and disadvantages. The following is a comparison of different S&P 500 derivatives, so that you can make informed choices which ones to use. TL;DR version provided at bottom.
| ||SPY ||SPY** Options ||SPX* Options ||/ES & /SP Futures ||/ES & /SP Options ||SPXU ||SPXU Options |
|Option Style ||N/A ||American ||European ||N/A ||European (except quarterlies) ||N/A ||American |
|Option Settlement ||N/A ||SPY Stock ||Cash ||N/A ||1x /ES or /SP contract ||N/A ||SPXU Stock |
|Annual Dividend Yield ||1.85% ||None ||None ||None ||None ||1.85% ||None |
|Net Expense Ratio ||0.0945% ||None ||None ||None ||None ||0.91% ||None |
|Leverage ratio vs SPY ||1:1 ||100:1 ||1,000:1 ||500:1 (/ES), 2,500:1 (/SP) ||500:1 (/ES), 2,500:1 (/SP) ||-30:1 ||-3,000:1 |
|Risk Management ||Stop order (non guaranteed) ||Guaranteed with defined-risk trades ||Guaranteed with defined-risk trades ||Stop order (non guaranteed) ||Guaranteed with defined-risk trades ||Stop order (non guaranteed) ||Guaranteed with defined-risk trades |
|U.S. Taxation ||Traditional capital gains ||Traditional capital gains ||Section 1256 ||Section 1256 ||Section 1256 ||Traditional capital gains ||Traditional capital gains |
|Relative Liquidity ||High ||High ||Med ||High ||Variable ||High ||High |
|Contract Expirations Traded ||N/A ||M/W/F weeklies, monthlies, quarterlies, leaps ||M/W/F weeklies, monthlies, quarterlies, leaps ||M/W/F weeklies, monthlies, quarterlies ||M/W/F weeklies, monthlies, quarterlies ||N/A ||Monthlies |
|Exchanges Where traded ||Most exchanges ||Most exchanges ||CBOE ||GLOBEX ||GLOBEX ||Most exchanges ||Most exchanges |
|Hours traded ||9:30-4 Eastern ||9:30-4:15 Eastern ||9:30-4:15 Eastern ||See here ||See here ||9:30-4 Eastern ||9:30-4:15 Eastern |
|Commissions ||Depends on exchange & broker ||High ||Med ||Med ||Med ||Depends on exchange & broker ||Med-Low |
*Note that SPX cannot be traded, as it is not an ETF like SPY. However, it is possible to trade *options* on SPX. Also, 1 SPY = 1/10 of SPX.
**Note 2: Northstat
helpfully points out that XSP
is a mini-SPX contract (european style, cash settled, and section 1256 tax treatment), but is sized 1/10 of SPX just like SPY. However, at a glance it seems to be pretty thinly traded, so use DD here if you decide to brave the bid/ask spreads.
There are two option styles: American and European. American options can be exercised at any time the option is ITM. European options can only be exercised upon expiration.
European options are simpler and more predictable since no one can exercise on you early and potentially screw up your trades, so I prefer them for day-trading for that reason.
Options can settle to the underlying equity or can settle to cash.
If you sell a cash-secured SPY put that expires ITM, you will be obligated to buy the SPY shares at the strike price, and will receive those SPY shares in your account.
If you sell a cash-secured SPX put that expires ITM, your account will pay the difference between SPX index price and SPX contract strike price in cash. There are no SPX stock/ETF/shares, so it settles with cash instead.
Annual Dividend and Expense Ratios
S&P 500 ETFs will pay dividends to the stock holder. Holding options
on those ETFs won't get you squat - you will only get dividends on shares that you actually in possess of in your account.
You'll notice that inverse ETFs like SPXU pay dividends just like the SPY ETF. That's because when you're shorting shares (which is effectively what ETFs like SPXU are doing), you get the dividends on the borrowed shares if you happen to be holding them on the ex-dividend date.
Most ETFs will also have an expense ratio, which cover the costs of managing the ETF. These fees have a compounding effect against you for ETFs held over the long-term. The SPY ETF expense ratio is fairly low, although it's worth noting that there are some mutual funds like FNILX
which offer a 0% expense ratio.
SPXU has a higher expense ratio in relation to SPY, but both the dividend payment (as well as the expense ratio) are effectively a non-factor, because you should not be holding inverse ETFs for more than a few days. In fact, the promised returns for leveraged inverse ETFs are only on a daily
basis, which is the holding period they're designed for. See here
to understand the problem with longer-term holding periods for leveraged ETFs.
Also keep in mind that some brokers offer a "share lending" program, which will pay you interest on shares loaned to other people who want to short those shares. When loaning your shares, you don't get the dividend payments (the borrower does). But one issue with these programs is that interest paid to you for share loans is taxed at your ordinary income rate, whereas dividends are taxed at the more favorable long-term capital gains rates (more on this further below).
Leverage Ratio Vs SPY
1 SPY = 1/10 SPX
1 /ES = 50 SPX
1 SPXU = 3 SPX
100 units per contract of SPY, SPX, and SPXU. 1 unit per contract of /ES and /SP.
/SP futures and options on 3x-leveraged ETFs have the highest total leverage. Use extra DD when trading these.
First, some terms. Defined Risk
= max loss is guaranteed to some known value. Undefined Risk
= max loss is unconstrained.
With options, you can avoid undefined risk when using the right spreads. For example, debit spreads are one way of limiting the maximum potential loss (which is limited to the debit paid to enter the trade).
With other instruments like stocks, you can set stop-losses as the desired loss levels. However, you run the risk of a gap-down, especially when held overnight or over the weekend, which blows past your stop limit.
Therefore, options are superior when it comes to risk-management when used appropriately. However, not all options trades are defined risk (e.g., naked puts).
Also note that your risk relative to the leverage ratios above. Obviously you are putting a lot more money at risk in one /ES options contract than in one SPY options contract.
The following explains tax implications as of 2020 for a U.S. citizen. It may be different if you are outside the U.S., but I can only speak to the U.S. tax code. Traditional Capital Gains
: 100% short-term
capital gains if holding period <= 365 days, 100% long-term
capital gains otherwise. Taxes are assessed at time of sale, regardless of holding period. Wash-sale rule applies for traditional contracts. Section 1256 Contracts
: 60% long-term
, and 40% short-term
capital gains/losses, regardless of holding period. Taxes are assessed at the end of each calendar year
regardless whether you sold it or not. Wash-sale rule is N/A for 1256 contracts.
I won't post the tax rates
here, but suffice to say as of 2020, long-term capital gains tax rates are much more favorable rate than short-term gains (roughly half, depending on your brackets).
Something else you need to understand about how capital gains are calculated. First, long-term gains cancel out long-term losses, and short-term gains cancel out short-term losses. Only after this can short-term and long-term capital gains/losses cancel out each other.
Some scenarios that help drive home the implications of the above:
- You trade Section 1256 contracts this year and are profitable. This saves you approximately 7-10% on taxes levied on your trading activity by trading contracts like SPX instead of contracts like SPY.
- You hold profitable Section 1256 contracts as long-term investments through the end-of-year. You are hit with 60/40 taxes on the "gains" of these contracts for tax year 2020 (even though you haven't sold them). You sell the contract a year after you bought it at a further gain in 2021, and pay the 60/40 split on your 2021 taxes for any additional gains since the 2020 end-of-year tax payment. You would have been better off with a traditional contract that A) would have deferred your full tax payment to 2021, and B) would be taxed at the more favorable 100% long-term capital gains instead of 60/40 split.
- You hold unprofitable Section 1256 contracts as long-term investments through the end-of-year. You get a 60/40 tax writeoff on the "losses" of these contracts for tax year 2020 (even though you haven't sold them). You sell the contract a year after you bought it at a loss in 2021, and get a 60/40 writeoff on your 2021 taxes on any additional losses since the 2020 end-of-year tax deduction. You have done yourself a favor in this case because A) you reduced your taxes in 2020 instead of deferring losses to 2021, and B) you have more useful short-term losses to offset other higher-taxed short-term gains, rather than 100% long-term losses for traditional contracts held for over 1 year. (If you're wondering why you can't take advantage of (A) for traditional contracts, lookup the Wash Sale rule.)
- You trade traditional contracts this year and are unprofitable. Your losses are 100% short-term capital losses, which is more helpful in offsetting other higher-taxed short-term capital gains you have from other trading activities (e.g. those sweet TSLA puts).
- You acquire SPY shares which you plan to hold for more than 2 years. You collect dividends and avoid paying taxes on capital gains, potentially indefinitely (i.e. if you never sell). Whereas with options, the farthest-dated LEAPs are 2 years out, after which time you would have to realize a capital gain or loss. You can sell covered calls for additional income, but may want to wait 1 year before doing so to avoid your shares being called away during that period and paying short-term capital gains. It's complicated.
- For profitable short-term trading activities (0-1 yrs), trade Section 1256 contracts
- For unprofitable short-term trading activities (0-1 yrs), trade traditional options contracts
- For profitable long-term trading activities (1-2 yrs), trade traditional options contracts
- For unprofitable long-term trading activities (1+ yrs), trade Section 1256 contracts
- For profitable long-term bets with > 2 year holding period, hold SPY shares. Sell covered calls after 1 year holding period for additional income if desired.
Since 1 SPY = 1/10 SPX, we expect bid/ask spreads for SPX options to be 10x as big as SPY. Anecdotally in the last couple weeks, I saw larger spreads than expected in SPX options, especially when IV got pumped up. This is the primary drawback I have seen so far trading SPX options.
/ES futures are very solid in daytime trading hours. I haven't traded /ES options and SPXU or SPXU options, so I'm not entirely sure how they compare.
Contract Expirations Traded
Keep in mind that different contract expirations will have different liquidity. In general, I have seen the highest liquidity for monthly contracts. Near-dated weeklies can be alright, but I usually see the largest volume on the monthlies.
I would avoid the quarterlies on SPX, as they seem to have the lowest volume. LEAPs are somewhere in between, and obviously is your only choice for long-term speculation besides owning SPY shares outright.
Exchanges and Hours Traded
Different contracts trade on different exchanges, and each exchange can have its own rules about hours of operation, comissions, etc.
For this reason it's possible that the same
contract could trade at different
hours depending which exchange your contract is traded on.
For example, CBOE allows for options trading on its exchanges for another 15 minutes after markets close, but this is not true for all exchanges. Furthermore, the same exchange
can have different trading hours
for different contracts
It gets even more crazy when you look at holidays and other special events, as different exchanges have different rules about when they shutdown depending on the day-of-week that different holidays fall on.
Depending on your broker, you may be able to select the desired exchange explicitly, or your broker may offer a "smart order router" which tries to intelligently route your order to the exchange with the best fill price.
Commissions vary widely depending on the exchange your order is routed to, in addition to your broker's fees. There are a lot of gotchas here. For example, some brokers (e.g. IBKR) levy heavy fees for trading /CL compared with other futures.
More generally, the total commissions you pay will depend on the type of contract, and will be inversely correlated to the leverage ratio. In other words, it's cheaper to trade one /ES options contract than it is to trade the equivalent 250 SPY options contracts. However, being mindful of your risk tolerance is the more important consideration here.
Reasons to trade leveraged inverse ETFs?
I haven't traded the inverse ETFs, so I don't know as much about them. However my understanding is that it could be advantageous to trade SPXU rather than buying premium-rich puts in a high-IV environment, or if you want to avoid the possibility of IV crush. There are also other ways to hedge IV (e.g. put spreads, options contracts placed on the VIX, etc). However, they have their own set of gotchas
We'll make the assumption that you're profitable, and that your primary motivation is choosing the most tax-advantaged strategy which matches your investment horizons. In this case:
- Use SPX options, /ES, and /ES options for short-term trades (trades closed in less than 1 year).
- Be careful if you hold any of these contracts through the end of the calendar year (you'll owe taxes on any gains because they are "marked to market").
- Consider SPXU and/or spreads or VIX IV hedging if IV is too high to buy straight puts.
- Use SPY LEAP options for trades that will last 1-2 years.
- Either roll-out at expiration for another 1-2 years, or exercise to hold SPY shares (see #3 below).
- In current high IV environment, cash-secured puts and put credit spreads work well for long-term bullishness.
- Hold SPY shares if you plan to keep them for over 2 years.
- SPY shares can be initially acquired with long-dated leaps above, or via a short-dated cash-secured put if you want to own spy shares sooner.
- Optionally begin selling covered calls for additional income after holding shares for 1 year.
TL;DR of TL;DR
Trade Index Options like SPX and futures instead of SPY to save on taxes and stick it to the IRS. Don't give mnuchin any more of your tendies, make him get them from big daddy powell instead. Money printer go brrr already and doesn't need your help, so don't give it.
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