Have Your Clients Warmed to SPY and SPX? What’s the Diff?Advice to the Advisor
“Many advisors have warmed to using options and products that use options in their portfolios in 2018,” Christopher Robbins writes in Financial Advisor magazine. “They have been encouraged by both more volatile markets in stocks and bonds and by the increasing ease and efficiency of applying the strategies.” In fact, not that long ago, the Chicago Board Options Exchange reported a new monthly volume record in October 2018 for S&P 500 options, at 41.4 million contracts traded.
Two of the most widely traded contracts on option exchanges are the SPY and the SPX. In a rather cryptic, historical intro to the subject of options, Yahoo Finance states: “When it comes to the battle of SPY versus SPX, the first may have more volume, but the second has more value.”
The SPDR S&P 500 (NYSE symbol SPY) is, in fact, the most widely traded contract on option exchanges. The SPX S&P 500 index options have far lower trading volume, but each contract is ten times the size of a SPY.
Underlying the SPY contract is the Exchange Traded Fund, and the price fluctuates based on buyers and sellers of the ETF. Underlying the SPX are the actual 500 stocks composing the S&P 500 Index, the SPX value is determined directly by the value of those 500 stocks.
As index options, SPX options are settled in cash, while SPY is settled in stock.
Fact is, Investopedia authors observe, for most of the 20th century the average investor had no avenue available to actually trade indexes, and “the listing of options on various market indexes allowed many traders for the first time to trade a broad segment of the financial market with one transaction.” Then came the development of ETFs, or exchange-traded funds. “On one hand, we can state that investors have never had more opportunities available to them. At the same time, the average investor can easily be confused and overwhelmed by all of the possibilities that swirl around him or her.”
At Sheaff Brock, where wealth managers rely more heavily on fundamental stock analysis as compared with technical analysis, incorporating SPYs allows a broad spectrum of investors the opportunity to take advantage of both the broad diversification of the S&P 500 and the difference that typically exists between the implied volatility and the actual volatility in the marketplace. In addition, advisors who lack the time or the inclination to direct and monitor option trades can outsource those tasks. For those clients comfortable with taking on incremental stock market risk, for example, the Index Income Overlay portfolio is a long-term, bullish play on stock investing using the SPDR S&P 500 ETF. This strategy makes use of put selling, with the options trading serving as an “overlay” on an existing portfolio which serves as collateral for the options account.
For advisors reluctant to take on the task of monitoring either SPY- or SPX-based transactions, the SPDR S&P 500, or SPY, can really be “the doorway to trading a broad segment of the financial market with one transaction.”