S&P 500 Index Options
S&P 500 index options are option contracts in which the underlying value is based on the level of the Standard & Poors 500, a capitalization weighted index of 500 actively traded large cap common stocks in the United States.
The S&P 500® index option contract has an underlying value that is equal to the full value of the level of the S&P 500 index. The S&P 500® index option trades under the symbol of SPX and has a contract multiplier of $100.The SPX index option is an european style option and may only be exercised on the last business day before expiration.
Mini-sized S&P 500 Index Option Contracts
To meet the needs of retail investors, smaller sized contracts with a reduced notional value are also available and goes by the name of Mini-SPX.The Mini-SPX index option trades under the symbol XSP and its underlying value is scaled down to 1/10th of the S&P 500.The contract multiplier for the Mini-SPX remains the same at $100.
|Product Name||Symbol||Underlying Value||Contract Multiplier||Exercise Style|
|S&P 500® Options||SPX||Full Value of S&P 500||$100 |
(Full Contract Specs)
|Mini-SPX Options||XSP||1/10th of S&P 500||$100 |
(Full Contract Specs)
How to Trade S&P 500 Index Options
If you are bullish on the S&P 500, you can profit from a rise in its value by buying S&P 500® (SPX) call options. On the other hand, if you believe that the S&P 500 index is poised to fall, then SPX put options should be purchased instead.
The following example depict a scenario where you buy a near-money SPX call option in anticipation of a rise in the level of the S&P 500 index. Note that for simplicity's sake, transaction costs have not been included in the calculations.
Example: Buy SPX Call Option (A Bullish Strategy)
You observed that the current level of the S&P 500 index is 815.94. The SPX is based on the full value of the underlying S&P 500 index and therefore trades at 815.94. A near-month SPX call option with a nearby strike price of 820 is being priced at $54.40. With a contract multiplier of $100.00, the premium you need to pay to own the call option is thus $5,440.00.
Assuming that by option expiration day, the level of the underlying S&P 500 index has risen by 15% to 938.33 and correspondingly, the SPX is now trading at 938.33 since it is based on the full value of the underlying S&P 500 index. With the SPX now significantly higher than the option strike price, your call option is now in the money. By exercising your call option, you will receive a cash settlement amount that is computed using the following formula:
Cash Settlement Amount = (Difference between Index Settlement Value and the Strike Price) x Contract Multiplier
So you will receive (938.33 - 820.00) x $100 = $11,833.10 from the option exercise. Deducting the initial premium of $5,440.00 you paid to buy the call option, your net profit from the long call strategy will come to $6,393.10.
|Profit on Long SPX 820 Call Option When S&P 500 at 938.33|
|Proceeds from Option Exercise||=||Cash Settlement Amount|
|=||(Index Settlement Value - Option Strike Price) x Contract Size|
|=||(938.33 - 820.00) x $100|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Proceeds from Option Exercise - Investment|
|=||$11,833.10 - $5,440.00|
|Return on Investment||=||Net Profit / Investment|
In practice, it is usually not necessary to exercise the index call option to take profit. You can close out the position by selling the SPX call option in the options market. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.
In the example above, as the option sale is performed on expiration day, there is virtually no time value left. The amount you will receive from the SPX option sale will still be equal to it's intrinsic value.
Limited Downside Risk
One notable advantage of the long S&P 500® call strategy is that the maximum possible loss is limited and is equal to the amount paid to purchase the SPX call option.
Suppose the S&P 500 index had dropped by 15% instead, pushing the SPX down to 693.55, which is way below the option strike price of 820. Now, in this scenario, it would not make any sense at all to exercise the call option as it will result in additional loss. Fortunately, you are holding an option contract, and not a futures contract, and so you are not obliged to anyway. You can just let the option expire worthless and your total loss will simply be the call option premium of $5,440.00.
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