Trading Options on the ES or the SPX

Posted April 10th, 2012 by Josip Causic in Education

Trading Options on the ES or the SPX

A question that puzzles some traders is what are the advantages of trading options on the S&P 500 futures versus the S&P 500 cash-settled index? After searching for that answer myself, I concluded that although they do appear to be very similar there is a subtle difference between the two. This article does not advocate trading one over the other but it aims to explain the contrast between the two.

Let us first show the similarities. The figure below shows the option chain for the S&P 500 cash-settled index. These options are European style, and they also have weeklies.

Figure 1

As can be observed, at the time of writing this article I had an Iron Condor on the SPX, so I want to use the premiums from this options trade as the point of comparison against the options on the E-mini S&P 500 shown in Figure 2. There is very little difference in premiums because the option pricing formula is still the same.

Figure 2

Not only is the premium similar but also their expiration dates are within a couple of days of each other and they both have weekly options. Now let us move onto the differences. The main difference between the two are the expiration styles and trading hours. First, the options on the S&P 500 cash-settled index are European style, as pointed out earlier, while the options on the E-mini S&P 500 are American style.

Second, the options on the S&P 500 futures trade beyond normal trading hours. This fact can be easily verified by going to the CME Group website, http://www.cmegroup.com/ and clicking on the third tab from the left (Equity Index). If you hover your mouse over the Equity Index Tab it lists in orange lettering US Index Futures and Options (CME). The very first line in blue reads E-mini S&P 500 (Dollar). Click that and it will bring you to the Quote page. Right next to Quotes is Contract Specifications. There are two tabs underneath Contract Specifications: Futures and Options.

Figure 3

When on the tab for Options of the E-mini S&P 500 we can clearly see the options trade Monday-Thursday from 5PM to 3:15 PM Central Time. The big institutions know this crucial piece of information (the extra long option trading hours) that is so deeply buried in the °∞library°± of the CME Group data. They use it and abuse it because Figure 2 shows the open interest on the weekly call and put options is there, and it is not the retail traders that have created the liquidity. Nope. Read more, watch less television.

While on the topic of S&P 500, let me give a brief technical analysis using the S&P 500°‰s Exchange Traded Fund ®C SPY. The daily SPY chart below shows several markings on it. The diagonal trendline from the October low connected with the November 25th, and the December 19th lows, represents the bigger trend which is intact. The green horizontal line (135.73) represents the highest point from July of 2011 that had acted as resistance (Supply Zone) back then as well as in February of the current year. The yellow rectangle marks the closing price of December 19th and opening price of December 20th as an unfilled gap. Hint ®C not every gap has to get filled.

Figure 4

If we place Fibs on the above chart then we get some interesting coincidences. The Fibs are attached to the low of December 20th and the highest point on February 29th. It is interesting to observe that the pull back of March 6th was to exactly the 23.60% Fib (bluish line). Also observe how the 50 day Simple Moving Average is not violated to the downside. In fact it nicely lines up with the big diagonal trend line. The fact that the Simple Moving Average is not broken could be construed as a sign of strength. Keep an eye on it because that area of the overlaid 50 SMA and the trendline might be a good point for a long entry.

Figure 5

In conclusion, although the premiums in the cash-settled S&P 500 options are very close to the E-mini S&P 500 options, there are subtle differences between the two. The E-mini S&P 500 options are American Style, have longer trading hours, and they do trade overnight. Keep that in mind when choosing between the two.

Have green trading, Josip Causic