INDEX OPTIONS

Index Leap Option Strategy Trading

Hedge Your Portfolio With This Index Leap Option Strategy Trading ETFs

Many investors who are saving for their retirement believe in the “buy-and-hold” philosophy using a combination of index and mutual funds. Unfortunately, this methodology means always being fully-invested in a market that can move to the downside at inopportune times. Luckily, index LEAPS can be used to help limit the potential downside, while preserving all of the upside.

Why use index LEAPS to hedge against potential downside? Suppose that the S&P 500 has recently moved off of its low with a strong fundamentally-driven rally, but you suspect that any new interest rate decisions could put the market at risk. While you believe the S&P 500 will move higher in the long-term, you are worried about a short-term rate hike, so you may decide to use index LEAPS to limit your risk.

But why not simply buy and sell the mutual funds instead? For one, some “load” mutual funds charge hefty fees for such transactions, while transaction costs from brokers can also quickly add up. More, investors hoping to rapidly sell a mutual fund when an adverse event occurs will also find that the value of their holdings are calculated at the end of the day – so they will incur the loss anyway.

Creating a Highly Effective Index Leap Option Strategy Trading With ETFs

The majority of investors place long-only equity trades in index and mutual funds within retirement accounts. Unfortunately, this majority is forgoing a key advantage of active trading and non-equity financial instruments – the ability to hedge. While hedging may sound like a complicated strategy, index LEAPS can make the process very easy for the average investor to mitigate portfolio risk.

Hedging Your Portfolio with LEAPS

The most common LEAPS index hedging strategy involves purchasing one index LEAPS protective put that correlates to each index or mutual fund holding in a portfolio. While this may seem pretty straightforward, there are three key steps to consider when executing the strategy.

Step 1: Formulate an Outlook
The first step to hedging a portfolio is to formulate a basic outlook on the market and your holdings in particular – bullish or bearish. If you’re a cautious bull, then hedging with this strategy may be a good decision. But if you’re a bear, it may be a better idea to simply sell the funds and reinvest in something else. Remember, hedges are designed to reduce risk, not cover up bad investments.

Step 2: Determine the Right Index
The second step is to find an index that correlates to your funds. Luckily, most index and mutual fund options included in retirement plans are relatively straightforward, with names like broad index, small cap, large cap, value-based and so forth. These funds can be hedged by purchasing protective puts using common Exchange Traded Funds (ETFs) like SPY for the S&P 500 or VB for small-cap stocks.

However, there are some funds that can be trickier, and you may have to read a prospectus or two in order to determine their holdings. For instance, if you find a fund tech-heavy, then perhaps the QQQ Exchange Traded Fund would make a good hedge, while a commodity-heavy fund may be better off with a commodity ETF. Again, the key is finding comparable indexes that correlate to your existing holdings.

Step 3: Calculate and Justify the Cost
The third step in creating an effective hedge using index LEAPS is calculating how many protective puts you should purchase to create the hedge, which can be done in two simple steps:

1. Divide the dollar value of your holdings by the price per share of the index.
2. Round that number to the nearest 100 and divide by 100.

Once you have the number of option contracts needed, you can look at the options table to find at-the-money puts at various expiration dates. Then, you can make a few key calculations:

· Hedge Cost = Number of Contracts x (Option Price x 100)
· Downside Protection = Hedge Cost / Dollar Value of Holdings

Finally, you can determine if the cost of the hedge is worth the downside protection that it offers at various price points and time frames using these data points.

Example: Hedging a Retirement Portfolio Using Index Leap Option Strategy Trading

Suppose that you have a portfolio that consists of $250,000 invested in an index fund tracking the S&P 500 through a company-sponsored retirement plan. While you believe the market is in recovery mode, you are nervous about recent economic developments, and want to protect your investment against any unexpected events that may occur over the next year.

After researching comparable funds, you discover the SPDR S&P 500 ETF (NYSE:SPY), and decide to purchase protective puts on that index. By dividing your $250,000 position by SPY’s current $125 price you calculate the size of the hedge – 2,000 shares, in this example. Since each option accounts for 100 shares, we need to purchase 20 protective puts.

If 12-month-out 125 LEAPS index puts on SPY are trading for $10 each, our hedge will cost approximately $20,000. By purchasing this hedge, you are limiting any potential downside in your portfolio to about 8% – the cost of the option – for the next 12 months, while leaving unlimited room for potential upside, if the S&P 500 continues to rise.

How to Use the VIX

Knowing how to use the VIX should be essential for all option traders whose portfolio of positions may be affected by general market sentiment. The reason is, because the VIX, or volatility index, represents the average implied volatilty in all options traded over the underlying shares that make up the famous S&P 500 index in the USA. Since the implied volatility in options represents future expectations of price volatility, the VIX becomes a barometer for potential broad based market volatility over the nex 30 days.

This being the case, the VIX may not be so relevant to positions where the underlying assets are shares in individual companies, unless the price action of those shares is sensitive to the mood in the overall market. Although most stock prices will react to general market direction, particularly when it is decisive, some company stocks continue to trade against the overall trend.

As previously stated, the VIX is most relevant to a broad based portfolio of positions and consequently, would be of most interest to those trading either index options, or options on index related Exchange Traded Funds (ETF’s). For example, if you trade options on the SPY, the QQQ or other ETFs that represent a broad based market, the VIX would be very relevant and should not be ignored.

What Is the VIX and Where Did it Come From?

The VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) market volatility index. Because it generally trades in the opposite direction to the S&P 500 index, it has been referred to as the “fear index”. It was developed by Prof. Menachem Brenner and Prof. Dan Galai in 1986 as an academic concept, but it was not until 1992 that the CBOE asked Prof. Robert Whaley to create a tradable stock market volatility index based on index option prices. Since then, the VIX has been computed on real-time prices.

Once established, like most indexes, by March 2004 you could trade futures and options on the VIX. Now there are even ETFs that attempt to mimic it’s performance.

How to Use the VIX in Conjunction With Your Option Trading Decisions

Let’s summarise what we’ve established so far:

The VIX represents the average implied volatility of all call and put options on a broad based basket of underlying shares that make up the S&P 500 index.
This implied volatility signifies the anticipated price movement in the S&P 500 over the next 30 days.
When the VIX level is low, the general market is moving slowly
When the market becomes volatile, the VIX spikes higher.
In most cases, when the VIX goes up, the S&P 500 goes down.

The theory about market volatility is, that it always returns to its mean. Periods of high volatility eventually come back to the mean, as do periods of low volatility.

So here’s how to use the VIX to your advantage. While other factors have an influence, a high VIX indicates increased investor fear while a low VIX, complacency. This is because market volatility draws fearful investors to panic buy option contracts in broad based indexes or their ETFs, in order to hedge existing positions, thus driving up the implied volatility in the premiums. Since fear is most present when the market is falling, it is usually the put options that become expensive and in turn, affect the VIX.

Editor’s Note:- Once You Understand This Trading System You’ll Never See Options the Same Way Again!

This being the case, the VIX can be used in the following ways:

1. As a warning signal of possible change in market direction. For example, if the market has been bullish and the VIX starts to rise, it means that investors are fearful of an impending reversal. So if you’re in the habit of taking contrarian positions (anticipating a reversal), you should always consult the VIX first.

2. When the VIX is high, this usually follows a market sell-off, so you should be focusing on call options. When it is low, you should be favouring put options.

3. If you’re using a range trading options strategy such as a calendar spread or iron condor, you want to be notified of any potential significant price movements which may threaten the breakeven boundaries of your positions.

4. If you like to trade straddle options, which relish market volatility, an upturn in the direction of the VIX following consolidation at low levels may indicate impending price breakouts. Alternatively, if the VIX is indicating market complacency, it may mean that option premiums for some underlying stocks are cheap. If this is at a time when the VIX is at low support levels, it could be the best time to put on long dated straddle positions.

A relative of the VIX is the VXN. The VXN is the volatility index for the Nasdaq 100 and therefore associated with the OEX in the same way that the VIX is with the S&P 500.

How to Use the VIX With the 10 Day Moving Average

The 10 day moving average has historically proven to be an accurate predictor of price reversals in the S&P 500 index about 70 percent of the time. The rule here, is that when the VIX level hits 10 percent above the 10 day moving average, it means that a sell-off in the S&P 500 has taken its course and there is a high probability of a reversal to the upside. Conversely, when it is 10 percent below this moving average, the potential for S&P 500 reversing to the downside is there. This can be very useful if you are trading with SPY options.

Take a look at the chart below, where we have shown a couple of examples of this.

You’ll also observe from the above chart, how the RSI can be used in conjunction with the 10 Day Moving Average, to confirm reversal points. Looking at the green and red arrows, indicating over-bought and over-sold levels at the same time as the 10 day moving average rule applies, has yielded some reliable results.

Knowing how to use the VIX effectively can be a most useful options trading technique which can provide you a significant edge over the markets.

Editor’s Note:- Once You Understand This Trading System You’ll Never See Options the Same Way Again!

Index Call Options

Index call options are a simple, yet generally stable, way to trade options. Stock indexes are more inclined to trade in predictable trends than individual company stocks – and for this reason, can provide a good option trading strategy. Assuming you believe the index will rise in the near future, your most profitable strategy might be to simply purchase an ATM index long call option contract.

The obvious benefit with going long index call options, is unlimited profit potential, since there is no theoretical price limit to which the underlying index may aspire before option expiration date.

* Profit = Index Settlement Value – Index Call Strike Price – Premium Paid

Unlike futures and spot forex positions, the risk on buying long calls is limited to the premium paid. You cannot go into margin call territory.

Index Call Options Example

Let’s imagine we are trading a broad based index such as the S&P500. These indexes represent a broad cross section of the entire market, which means their price action is much more predictable than for individual companies.

We believe the index will advance further north in the near future and wish to take advantage of this. We have a choice of the following:

Buy OTM index calls … OR
Buy ATM index calls … OR
Buy ITM index calls

Each of the above scenarios comes with it’s own risk to reward ratio and probability of realizing a profit. The out-of-the-money (OTM) calls are naturally cheaper, but will only become profitable once they are sufficiently in-the-money to pay for the premium and then some. However, the longer time we allow before expiration, the greater the likelihood this will be achieved.

So imagine the S&P 500 index is trading at 1800 and we wish to purchase ATM call options with 120 days to expiration. We would pay around $53.80 per option contract. If the S&P 500 rose to 1900 at expiration date, the options would be 100 points in the money.

Our profit on these index call options would be:

1900 – 1800 – 53.80 = $46.20 profit per option contract.

NOTE:- this is at expiration. If the underlying reached that point before expiration date, there would also be some “time value” in the premium, giving additional profit.

In the money index call options would be more expensive, but they would also have a greater options delta. This additional delta would provide greater protection should the price go against you, but in percentage terms, less return on risk when in the money.

Commissions on Index Call Options

Because we are entering a simple position, going long index calls, the commissions will be cheap when compared to other strategies. They would be typically between $10 and $20 depending on your broker.

What Is An Index Option

So what is an index option and how does it differ from other financial instruments? To answer this question, we need to set the background with a little bit of history.

Stock indexes have been around for a long time, the most notable of which is the Dow Jones Industrial Average (DJIA) which featured prominently in the infamous 1929 Wall Street Crash. Indexes are nothing more than a weighted average of a basket of financial instruments such as shares or commodities. They are not publicly traded financial instruments in themselves. No one buys or sells an index.

There are many types of indexes. Some cover groups of stocks, others cover industry groups, currencies or commodities. Some are broad based, such as the Russell 3000 and the S&P500, while others are more narrowly focused.

If you aspired to be a trader back in the mid 1970’s, your primary form of investment would be to buy shares in individual companies in the hope that the price would rise so that you could sell them for a profit. However, since that time, with the advance of technology and the proliferation of firms specialising in managing funds, a boatload of new financial instruments have appeared.

The futures market has also been around for a long time, but in the early 1980’s, stock index futures were introduced as tradable instruments. For the first time, traders could now speculate on the future direction of an index. As things progressed, options on index futures were offered … and finally, options on the indexes themselves.

Unlike futures, options don’t carry the same negative risk, because when you buy options, the most you can lose is the amount you’ve invested. Unlike futures, options carry rights but not obligations. This makes them an attractive investment vehicle.

So what is an index option? It is the right, but not the obligation, to the future financial value of a calculated number. If you own call options on an index and the number rises, you profit. If the index falls, put options will profit. Simple as that.

Because an index is not an asset in itself, there are some special conditions that come with index options. Index options are “cash settled”. This means that you cannot exercise the options and receive the underlying asset, as you can with stock options. The value of the options cannot be translated into assets so they must be settled for their cash value. You can buy or sell index options during any trading day but you cannot exercise them for their cash value until after the market has closed.

What is an Index Option useful for? Well, you can use them to hedge a portfolio of shares against general market movements, or you can trade the options themselves. One of the advantages of an index is, that unlike company shares, they are not so susceptible to overnight price gapping due to news events. This is because they cover a broad base of underlying stocks such that the price action of one individual company is unable to influence the value of the index as a whole. This allows traders to hold their index options for longer periods with a greater degree of certainty about price movement.

What is an Index Option Compared to an ETF Option?

Exchange Traded Funds (ETFs) are a more recent invention. These are companies whose shares are publicly traded, but their sole asset base is comprised of a basket of stocks or futures that represent any given index, or other market for that matter. As such, the price action of ETF stocks correspond to the changing value of the index.

Since Exchange Traded Funds are stocks that can be owned or traded, an investor can use options on ETF stocks to achieve the same thing as if they were trading index options themselves. Not only that, but ETF options are much cheaper and consequently, attract a much greater open interest and daily trading volume.

Trading options on ETFs in a particular way form a significant component of the popular Trading Pro System developed by veteran trader David Vallieres.

For further reading, go to ETF Options.

Index Options Vs ETF Options

When you’re trying to decide about index options vs ETF options, you might initially have a hard time figuring out which one is best. They both have their advantages and disadvantages. So let’s explore these differences. You should look at what you are receiving as well as how everything is going to work for you.

The advantage that ETFs and indexes have in common is, that because they are both averages of a large basket of company stocks, they are not subject to the same level of unpredictable price fluctuations that come about following news events. An individual company’s share price might jump overnight by 35 percent following a takeover bid, but the index which it forms part of won’t be affected the same way, as the balance of all the other companies included in the index will dilute the effect. It takes a more general market move to affect an index. This makes for more predictable trading.

The Real Differences Between Index Options vs ETF Options

So let’s explore index options vs ETF options by taking each one individually. ETFs (Exchange Traded Funds) are by far the more highly traded of the two. A major reason for this is the fact that ETF options will change in value throughout the trading day while index options are settled only after the closing bell. Trading ETFs makes it easier for day traders to take profits. For other traders, it also means that your positions will be filled more easily. For example, at the time of writing the QQQ (ETF) is the most highly traded financial instrument on the planet.

Index related ETFs function like normal listed companies. If you hold shares in an ETF at “ex-dividend” date, you receive dividends. If your option contracts are exercised, you are delivered the underlying shares. When we say “index related” it means that the basket of shares or derivatives held by the fund is designed to mimic the price movements of a stock index.

Index options are mostly European style options (with the exception of the OEX) and can only be cash settled at expiration date. ETF options are American style options which can be bought and sold anytime at their exchange traded price.

Here are some examples for the US markets:

The ETF for the S&P500 index is called the SPY.
The ETF for the Dow Jones Industrial Average is called the DIA.
The ETF for the Nasdaq100 index is called the QQQ.
The ETF for the Emerging Markets index is called the EEM

There are also ETFs for industry sectors, currencies, treasury bonds and commodities, but here we are concerned about comparing stock index options vs ETF options.

Since ETFs come in many different types, you will be able to find a market or industry that suits you. Simply go through the options out there and find one that matches up with what you are looking for.

Because ETFs are much lower priced than their related indexes, they provide much greater flexibility for trading opportunities. For example, when the S&P500 is trading at 1200 points, the related share price of the SPY (ETF) will be around $120. Call or put options on shares trading at $120 will be much cheaper than on their 1200 point counterpart. One option contract on the SPY exposes you to $12,000 in market value, while the same on the S&P500 (SPX) requires $120,000 in market exposure.

Before you jump on either side of the index options vs ETF options debate, you should think about what you need. Overall, they are very similar in terms of price action, but ETFs provide far greater liquidity, flexibility and opportunity, both for day trading and more advanced options strategies such as iron condors and calendar spreads.

When you are thinking about index options Vs ETF options, you should take into account how they differ and what would be best for your individual needs so that you can make the most from your investment.

Video Version – Index Options vs ETF Options

ETF Options Trading

Grow a Small Account Quickly with ETF Options Trading

ETF Options Trading when combined with the right options strategy, can be one of the best and safest ways to profit consistently from the financial markets. Here, we’re going to explore some of the reasons why.

Firstly, ETFs, which is an acronym for Exchange Traded Funds, are available for a wide range of markets including stock indexes, stock market sectors, various commodity sectors and currencies. This provides great versatility for the active trader because even though one market may be quiet at any given point in time, another one will be on the move. For example, the stock market may be stagnant but a currency is trending, and so forth.

If you wanted to trade the currency or commodity markets, you would probably have to resort to futures, CFDs or forex pairs if you want the benefit of leverage. Trouble is, all these types of financial instruments carry unlimited risk – which means that should market price action turn against you, you can lose more than your entire trading capital.

The maximium risk with buying options on the other hand, is limited to the investment amount – and if your preference is to trade simple long options positions, ETF Options trading is your best choice.

Here’s why:

1. Most ETF options have low implied volatility, which is what you want if you’re buying options. This low IV also means that should the trade be going against you, your losses will be reduced because you have bought the options cheaply in the first place. Low IV also allows you to give yourself the gift of time for the trade to work out in your favour.

2. ETFs have no huge and sudden price surges that arise from news events such as earnings reports, management incompetence, product disasters, SEC investigations or the like. This is because they represent huge underlying, often broad based, markets, where the fortunes of individual companies can’t affect the market as a whole.

3. ETF options trading ensures you’re using financial instruments that have high daily volume and since the underlying market is huge and broad based, price action cannot be manipulated by market makers. This allows you to leave the trade active and sleep at night.

4. Unlike individual companies, Exchange Traded Funds tend to trend in a predictable and fairly even manner. Once a trend is established, it is more likely to continue rather than whipsaw all over the place.

5. ETF options can be purchased for cents, which is very good for traders with small accounts. For a few hundred dollars you can set yourself up for over a thousand in profit. It also means there is no need to employ advanced options strategies along with increased brokerage fees. You can just buy single options positions.

6. Since ETF’s are available on securities other than stock market based instruments, (even though they behave like stocks, paying dividends and so forth) you can use them when the stock market is showing price volatility. For example, the Dow Jones might fall 300 points in one day, but on the same day, a commodities based ETF may rise moderately, or a currency based ETF may even move sharply upward. This allows investors to broaden their portfolio of positions so that they are not entirely at the mercy of the stock market.

This is ideal for those using the popular Trading Pro System, which teaches you how to approach option trading like running a business. Like any business, you need a portfolio of unrelated products – in this case, option contracts – so that even if one “product line” only breaks even, your entire “business” still makes an overall profit.

A Simple ETF Options Trading Strategy

Let’s say you can see that the Japanese Yen is falling. Did you know that the Yen has an ETF in the US markets and there are also options on this ETF? It’s symbol is the FXY.

You use the weekly charts for the Yen as your guide to how far the currency can be expected to move. You then apply fibonacci percentages to anticipate your profit targets.

So you purchase put options contracts on the FXY, each having a delta of -20 and at least 4 months to expiration date. Most brokers will give you the options delta. The cost for these options would be around 25 cents each, so if you purchased 10 contracts, the risk would be 10 x 100 x 0.25 = $250.

This way, you risk the smallest amount but with the greatest potential leverage and four months for it to realize a good return on investment.

ETFs will often move between 8-10 percent in value over a few months. This will push your cheap options deep into the money where the profits can be spectacular.

It is important that using the above strategy, you pay attention to position sizing. Never risk too much on any one trade! There are plenty of ETFs with options to provide multiple trading opportunities – and all you need are some trades with impressive profits to outweigh the small losses you might experience on other trades where your dirt cheap options with low IV don’t work out.

Here’s a List of Some ETFs with Options

QQQ – follows the Nasdaq 100

DIG – follows the price of oil and gas

EWJ – Japan Index for smaller accounts; can’t chart it though

EFA – iShares MSCI EAFE Index Fund

EWZ – iShares MSCI Brazil Index Fund

USO – United States Oil Fund

GLD – follows the Gold price

GDX – Market Vectors Gold Miners

XLE – follows the energy sector

XLF – follows the financial sector

XRT – SPDR S&P Retail

IWM – follows the Russell 2000 stock index

FXI – follows the China 25 Index

TLT – follows Treasury Bonds

EEM – follows the emerging markets sector

DIA – follows the Dow Jones Industrial Average

SPY – follows the S&P500 index

SLV – follows the price of Silver

UNG – follows the price of natural gas

NUGT – triple leverage ETF but IV is higher, but moves really well

DUST – triple leverage bearish gold ETF, IV is higher, but moves really well

FXY – follows the Japanese Yen

DBC – follows the top 14 physical commodities worldwide

And there are many more . . .

Here’s a Simple But Effective ETF Trading System that Works!

Using the VIX Index

Using the VIX Index to Enhance Your Trading

Using the VIX index gives you a clear trading advantage. The VIX acts like a barometer for the fear and greed that the broad market base of market players are feeling and as such, can be used as a tool to help you get a feel for where the market is likely to go. It can also guide binary options traders who are interested in trading the S&P 500 index. The VIX is a measure of the implied volatility of the at-the-money calls and puts of the S&P 500 index, and reflects the level of premium that needs to be paid to purchase at-the-money options.

Implied volatility is an estimate of the distance the S&P 500 index will move over a certain period on an annualized basis. Since the VIX is a measure of market implied volatility, this is relevant. For example, a VIX reading of 13.98% means that market participants believe that over the next 30 day period, the S&P 500 index will move an annualized 13.98%, which translates to 1.17% over the next 30 days.

Using the VIX index effectively works like this. The VIX will generally move higher when the market is in fear of impending reversals, as investors will pay higher put option premiums for protection against downward price moves in the stocks that make up the S&P 500 index. The index will usually decline when complacency is on the rise, as traders believe this broad based index will remain subdued.

The general idea is that the VIX goes up while the S&P 500 is falling. Looking at VIX charts that cover the period of the global financial crisis will confirm this. An investor can use the negative correlation to potentially predict movements in the S&P 500 index, or the market generally. As fear rises, and the VIX climbs, there is a higher chance that the S&P 500 will make a downward movement. The VIX can also be used as a contrarian indicator. When the VIX is low for a while, and complacency sets in, traders are not prepared for a shock, and therefore could experience a wild ride.

So if you’re into option trading strategies that involve the major indexes, or ETF’s such as the SPY, the DIA or the QQQs that are derived therefrom, using the VIX index becomes a very valuable enhancement to your strategy. For example, if your using Calendar Spreads or Iron Condors, which rely on the market to be reasonably complacent, checking the VIX before you time your entry might be something you won’t regret.

Using the VIX index in conjunction with safe option trading for consistent monthy income, is one of the hallmarks of the popular Trading Pro System series of videos.

Trading Index Options

Some Advantages of Trading Index Options Over Stock Options

Trading index options was first made available to investors in 1981. The concept of trading index options is that they are not comprised of one stock, but rather made up of an index that has many stocks. Investors and market speculators trade these types of options so that they can get exposure to the entire stock market or market segments by placing a single trade.

Index option trading allows investors to benefit from diversity in their portfolio without having to buy stocks separately. Holding positions in index options enables trader to keep easy track of what their portfolio is doing since all stocks are combined. As owning stock in index funds allows traders to buy and sell their entire portfolio with one transaction, it also means that it`s a lot less expensive than paying for separate stock transactions.

Trading index options is similar to trading equity options in that they give the investor a predetermined risk and leverage. Index option buyers receive leverage because the premiums that are paid relative to the value of the contract are small. As a result, when the index moves even a small percentage, the index options investor can realize a large gain percentage for their position. In addition, risk is predetermined since the most that the trader can lose is the premium that has been paid to hold options.

Index options generally have a contract multiplier that is worth $100. Contract multipliers are used to compute the amount of cash value that every index option contract has. Like equity options, the options premiums of indexes are quoted in dollars and cents. Prices of single equity index options contracts can be easily determined by multiplying quoted premium amounts by the contract multipliers. This calculation allows the index options investor to find out how much needs to be paid to purchase the option, as well as how much money will be received once the option is sold.

Since index options are settled in cash, the options holder does not own or have the right to sell the underlying stocks that make up the index. Instead, the index options trader is entitled to get compensated in cash from the option writer when the option is exercised.

Trading index options is generally less volatile than trading individual stocks on the market. Individual stocks can be affected by takeover rumors, earnings reports and news, as well as other events in the market. For this reason individual stocks can be very volatile. Index options, on the other hand, tend to be smoothed out by the action of the index as a whole. This helps index options to avoid the wild ups and downs of individual stocks and maintain lower fluctuations.

Reasons Why Trading Index Options is Easy

Trading index options is very popular among options traders, investment firms and hedge funds. Because of this popularity, the volumes that are available to trade are driven up and this reduces the spreads quoted in the markets. Because of this competition, it should ensure that index options investors should always have plenty of volume and fair prices to conduct their trades.

An even more effective way to access the benefits of indexes, is to take options positions in the Exchange Traded Funds (ETFs) whose entire portfolio consists of a weighted average of the stocks that make up a particular index. Consequently, their stock price fluctuation is directly linked and a reflection of, the movement in the index itself. Some of the most highly traded and well known stocks in the world are index based ETFs such as the QQQ, the SPY and the DIA. You also receive the added benefits of dividends if you hold these stocks – but unlike index options, they are not settled in cash; you’ll end up owning the ETF stock if the options are exercised. There is a more complete coverage of index ETFs and how to make the most of them in the popular Trading Pro System series of videos.

It’s important to distinguish between index options and index futures – although you can also trade options on these futures. Futures options cover a wide range of indexes, including currencies such as the US dollar index.

Stock Index Options

What Stock Index Options are and The Best Way to Trade Them

If you’re interested in trading stock index options, it pays to know what they are and how they differ from normal stock options. With that covered, the question remains whether stock index options are really the better alternative to their counterpart – the Exchange Traded Index Fund.

A stock index is a measure of the average value of a basket of associated stocks. Sometimes the basket is quite small, such as the Dow Jones Index, which includes only 30 major stocks. On the other hand, some indexes are quite large, such as the Russell 3000 – the number being indicative of how many stocks are included. These are called “broad-based” indexes. Other indexes cover industry groups such as mining, energy, utilities, financial and resources markets and are called “narrow-based” indexes.

For option trading purposes though, the thing about stock indexes, is that an index is not something that can be physically delivered to you like company shares can be. So if the time comes when you choose to exercise stock index options, the only way it can be settled is by receiving the cash value of the index at exercise date, multiplied by 100 (because one option contract covers 100 of the underlying asset).

Stock index options are known as financial derivatives because they derive their value from the current market price of the index itself. The beauty of an option contract is, that it allows you to purchase or sell rights to the changing value of the index without having to shell out the full value of the index trading price. Being able to benefit from price movements in the larger value while only investing a fraction of its cost is called “leverage”. Take the Dow Jones for example. If it’s trading at 12,000 points then you may not be able to afford to buy 1 unit at that price, but you may have enough to purchase a call or put option on the Dow. But as we shall see, there is an even better alternative to this.

A call option gives you the right to buy the index at a specified price up to an agreed expiration date. A put option gives you the right to sell the index under the same conditions as for calls. If you can buy cheaper when the trading price is higher, you make a profit. If you can sell for more, when the trading price is lower, you also make a profit. The only thing to bear in mind is, that although stock index values change throughout the trading day, stock index options only change in value at the end of the trading day, so are not suitable for intraday trading. But there is an alternative.

Stock Index Options Alternative

Enter the Exchange Traded Funds (ETFs). These are large fund managers, who purchase the basket of underlying stocks which make up the relevant index. The index therefore becomes a reflection of the value of the fund. You can purchase shares in the fund and theoreticlly, your share value will change in accordance with the changing value of the underlying index.

But ETFs also offer options on their shares. Because the ETF share price moves in alignment with the index, option contracts on ETF shares become a defacto way of trading the index option. Since the share price of the ETF is about 100th of the value of the index, the options on ETFs are much cheaper than the stock index option itself – and yet yield the same results.

Some of the more well known Exchange Traded (Index) Funds are:

QQQ – reflects the Nasdaq 100
SPY – reflects the S&P 500
DIA – reflects the Dow Jones Industrial Average
EEM – reflects the emerging markets index
IWM – reflects the Russell 2000 index

All the above have greater liquidity and consequently, much more flexibility than trading the stock option itself. Some of the best option trading strategies such as the Trading Pro System have been created with stock indexes in mind.

Index Options Advisory Service

What a Good Index Options Advisory Service Can Do For You

There could be a number of reasons you’re looking for an index options advisory service, but I suspect the primary one would be to find some guidance about the future direction of the major stock market indices, with a view to trading them.

The next question of course would be, on what exchanges and which countries would you be looking for your index options advisory service? My suggestion is, go for the place that has the largest market in the world and the most liquid index options. That would have to be the USA. It is not only the place where you’ll find the most indices to trade, but the “American Style” options trading system means that you can close out your positions at any time up until expiration date – unlike their European brothers across the Atlantic.

Since the USA is the largest stock market in the world, it stands to reason that it is also where you will find a more plentiful supply of index options advisory service providers on offer.

Now we need to decide which index options we prefer to focus on. Here I would suggest, that as far as the advisory aspect goes, you look for information on the Dow Jones, the Nasdaq100 and the S&P500 but as far as your actual trading goes, you turn to the Exchange Traded Funds (ETF’s) whose portfolio of shares attempts to mimic the indexes. The options are much cheaper here and the open interest is spectacularly higher. Not only that, but whereas the index options themselves are European Style – i.e. cash settled at expiration date and can’t be closed out until then, the ETF’s are like any other stock and trade “American Style”.

Here are your recommended ETF’s:

QQQ – tracks the Nasdaq 100 index

OEX – tracks the S&P100 index

SPY – tracks the S&P500 index

DIA – tracks the Dow Jones Industrial Average

IWM – tracks the Russell 2000 index

EEM – tracks the Emerging Markets Index

So How About an Index Options Advisory Service?

There are a number of services available, but one that I have found most useful is the Daily Market Advantage. It not only provides a daily video commentary on the major indexes, but also includes long and short term trade recommendations using more advanced option trading strategies.

The Daily Market Advantage vendors offer a 30 Day Trial of their product for only $9.95. That way, you can get a feel for whether it is for you, without spending too much. If you like the service after the trial period, you simply do nothing and they’ll continue to take your subscription payment monthly. You can even subscribe with Paypal to give you greater control.

Highly recommended!

Index Option Trading

The Benefits and Preferred Methods for Index Option Trading

One of the primary benefits that distinguish index option trading, is that the price action is much more stable than it is for individual stocks. The shares of an individual company may unpredictably skyrocket or plummet overnight as a result of breaking news such as an earnings report, a change in executive management, an unforeseen disaster, or new discovery. But this type of price action is very rare with indices.

The simple reason for this is that because indexes are comprised of and an average weighting of many stocks, the impact of one individual company, on the whole, is minimal. A possible exception to this may be a major player in the Dow Jones Industrial Index rising or falling by more than 10 percent in one day – since only 30 companies form its repertoire.

But by and large, the other indexes such as the S&P500, the Russell 2000, and the Nasdaq 100 include so many top companies that it takes a major economic shift in the overall market to make an impression.

The other feature about index option trading, is that indexes and their associated Exchange Traded Funds (ETFs) are a highly liquid financial instrument. The volume and open interest in indexes, particularly ETFs that are aligned with them, is constantly growing. This means positions are easily entered and exited, usually without much slippage. For this reason, traders are able to take advantage of broad market moves and tailor their option trading strategies to suit.

Why ETF’s Are Preferred For Index Option Trading

Let’s say you wanted to trade the S&P500 index and at the time of your decision, the SPX is trading around 1330 points. You believe that by next month’s expiry date in 45 days, it will fall to around 1250. You could purchase put 1300 options on the SPX but at that price level, each option contract would cost you about $28.70.

Just one contract would cost you $2,870.

On the other hand, you could consider buying put options in the SPY, which is an ETF whose portfolio of stocks is a weighted average of all the companies that make up the S&P500. This means that price movement in the SPY track those of the S&P500 index.

Looking at put options for the SPY with 45 days to expiration, the price for one contract is only $2.86 which is about 10 percent that of the index itself. Not only that but whereas the open interest on the S&P500 1330 puts at the time of writing is 3,289 … the same on the SPY 133 puts is 41,638.

See why ETFs are more attractive?

Not only is the liquidity unquestionably greater, but since the options are also much cheaper, you have much more flexibility in terms of how many contracts you wish to purchase according to whatever trading capital you have. This may be particularly significant if you are using a strategy that requires you to adjust or add to, your existing positions.

Trading Binary Index Options

Binary options are a relatively new and increasingly popular mode of options trading because the concept behind it is simple – you either get paid a nice profit (usually about 70 percent) or you don’t. There are no complex options formulas, implied volatility, or time decay elements to worry about. It’s just a simple matter of getting your prediction right or wrong – that’s the binary part.

Binary options cover a number of major indexes around the world.

The Best Index Option Trading Strategies

We have already established that index options are far less susceptible to unpredictably volatile behavior. This makes them a prime candidate for range trading option strategies. There is one certainty about options and that is, that they will eventually expire – and during the last month before expiration, their out-of-the-money time value (theta) decreases exponentially. If you understand how powerful this factor is, you can craft an almost risk-free, low-stress, index option trading strategy that just keeps on serving up profits month after month.

If you would like to know more about how you can do this, take a look at the Options Trading Pro System. I love it! Why? Because it just keeps on working – and if you do it according to the instructions, you can expect around 50 percent return on risk each month.

You need to “paper trade” for a few months so that you fully grasp all the elements of the strategy and how to implement them. The broker and trading platform they recommend includes that facility. But once you’ve “got it” – after that, it’s just a question of “how much money do you want to make?”

index option trading

Index Options Calculator

Finding a Good Index Options Calculator Without Paying For It

To be effective, a good index options calculator needs to be able to determine two important things:

1. The amount you would receive at expiry date if the option contract expires ‘in-the-money’ and it is cash settled.

2. The relationship between price movements in the underlying index and the changing value of the options contract. In other words, how much do you win or lose for each one point move in the index?

Finding a good index options calculator is not always an easy task. Just do a search on Google for the term in quotes and you won’t find much out there. So in the end, a good options analysis tool should suffice. One of these should provide you at least with a risk graph and profitabilty analysis which can be adjusted on a daily basis, down to expiry date.

Index options only differ from stock options in the way they are settled. If you hold a stock option contract and choose to exercise it, you either buy or sell company shares at an agreed price. But index options are settled in cash, if they are ‘in-the-money’ at expiry date.

So the bottom line is … you simply need a good options analysis tool and your index options calculator problems are solved.

Now, the next question is, do you want to pay for such a tool or would you prefer to have access to a free tool that gives you everything you need, to analysis your index option trades?

There are some rather expensive options analysis tools out there, which include market scanning and trading pattern locators, portfolio analysis and other advanced features such as Elliot Wave analysis etc … often running into price tags up to $5,000. But if you are trading only index options, your trading opportunities are probably more limited, so you would be inclined toward finding a tool that simply calculates your potential profit or loss with an easy to follow interface.

I Got My Index Options Calculator Here

With the above in mind and assuming you want to trade in the US markets, may I suggest you consider opening an account with ThinkorSwim options brokers. You need a minimum $2,000 to start trading with, but once you open an account with them, they provide you one of the most advanced trading platforms that I’ve seen anywhere, at no cost, that you download from their website. It includes a full featured options analysis tool, which allows you to analyze any options positions you are looking at. These include advanced option strategies such as iron condors and calendar spreads.

At a glance, you can see a risk graph for your proposed index options positions and also scroll through changing price movements in the underlying together with a daily countdown to expiry date, to see the effect these have on your profitability. This makes it a good index options calculator – and in all likelihood will be all you’ll ever need.

OEX Option Trading

OEX Option Trading Has Some Clear Advantages

Before we launch into the subject of OEX Option Trading, we need to establish a foundation for the subject. The $OEX is the code that represents the Standard & Poors 100 (S&P100) which is an index of the top large cap 100 companies listed on stock exchanges in the United States. The index covers a range of industries, but is constructed so that larger companies have a greater influence on it. For this reason it is known as a market value, or capitalization weighted index.

You’ve probably heard of the S&P 500 which is a broader based index of the top 500 US companies. Well the OEX is simply a subset of that. It is a good barometer of the overall mood of the blue chip stocks in the US markets.

OEX option trading is simply about trading a derivative product (options) whose values are based on the price action of the underying $OEX index. It was launched in 1983 as the world’s first optionable index and until recent times, has been the most popular index option. But in recent years its popularity has waned, as other rival products have come onto the market such as the Nasdaq 100 Index Trust, commonly known as the QQQQ or the “cues”. The QQQQ is currently the most liquid and highly traded index in the world.

Another use for the OEX over the years has been as a hedging instrument for a portfolio of blue chip stocks. OEX put options have provided valuable protection against falling stock prices for large fund managers. For this reason, OEX put option volume is generally greater than call option volume.

In connection with OEX option trading, a trader should always keep an eye on the VXO – the code for the S&P 100 Volatility Index on the Chicago Board Options Exchange (CBOE). The VXO indicates the level of put options that are being purchased and therefore the likelihood that a rising market is due for a reversal. It works opposite to the OEX in that, when the VXO is rising, the OEX is falling – or is about to.

OEX Option Trading with the OEF

The OEF is the code for an Exchange Traded Fund (ETF) called the iShares S&P 100, whose portfolio of stocks mimics the composition of the S&P 100. As such, it’s price action follows its big brother, the larger OEX. The difference between the OEF and the OEX is that the first, being an ETF, is an actual stock whereas the second is an index. Indexes are cash settled financial instruments, whereas stocks are settled by transfer of the underlying shares. Stocks also include dividend payments whereas indexes don’t.

But the OEF is useful in that its option prices are much cheaper and more liquid than the OEX options and therefore more accessible to traders with a smaller capital base. This being the case, you can more easily fine tune the amount you choose to risk on any one trade.

The beauty of index option trading in general is that, unlike stocks, they are usually less volatile, because they are an average of a large number of stocks.

One of the best systems I have found that takes advantage of index options, is the Trading Pro System. It is a system that educates you to “trade by the numbers” and focuses on treating your trading as a business whose inventory is a portfolio of options – in particular, index options.

Spider Options Trading

Spider Options Trading – A Better Alternative Than S&P500 Index Options

Spider options trading is a term used to describe a trading strategy focussed on options contracts associated with an exchange-traded fund (ETF) commonly known as “The Spider” (or Spyder). This ETF is one of the biggest investment funds in the USA and exists for the purpose of holding a basket of stocks that represent the Standard and Poors 500 selection.

After the Dow Jones Index, the S&P500 is the second most widely followed index because it represents a weighted index of the top 500 actively traded large-cap stocks in the USA. The ‘spider’ is an ETF that is designed to mimic the price movements of this popular index. The stock exchange code for the spider is SPY.

The name ‘spider’ is a shortened version of the acronym used to represent the correct name for a family of investment funds known as Standard and Poors Depository Receipts (SPDR). The first member of this family is the SPY. Other well-known funds follow other indexes and include the DIA (Diamonds) which follows the Dow Jones Industrial Average.

Spider options trading is considered a safe alternative to trading options based on individual stocks because it avoids the unexpected price moves that can arise as a result of news items about a particular company. One stock price in the index may rise or fall dramatically following a news release but it will have little effect on the overall weighted balance of the remaining 499 large-cap stocks that make up the index.

Why Spider Options Trading is Safer

If your options trading strategy relies on a more stable and somewhat predictable price fluctuation, taking options positions derived from the SPY as the underlying security is a preferred approach. Since the SPY basically follows the S&P500 large overnight price gaps are virtually unheard of. Apart from major global financial meltdowns or events like the 1987 stock market correction, (which only seems to happen every 20 years or so) the SPY is a trading instrument that can be relied on.

Spider options trading is also a very liquid market which means you should find it easy to get your position filled. A number of option trading strategies have been developed based on the SPY. One, in particular, has caught my eye because it uses the double calendar and iron condor spreads to take advantage of option time decay. Learning the art of adjusting your positions in combination with these strategies brings reliable and consistent returns, providing the trader with a sense of confidence.

If you wish to learn an excellent options trading strategy based on ETF’s that follow indexes such as the SPY, the DIA, and others, I highly recommend the educational video series by Tradingology. I have watched these videos and can assure you that they are very professionally presented and explain all you need to know in great detail. In fact, each one ends with the speaker’s characteristic assurance … “trade with confidence”.

Spider Options Trading With Binary Options

Binary Options Trading is a more recent innovation, so much so that it barely resembles the characteristics of traditional, or “vanilla” options. The concept is simple – you predict an outcome for the underlying, if you get it right, you get paid about 70 or more profit, if you don’t, you lose 85-100 percent of the amount you risked. Two simple outcomes – hence, binary.

Binary options are traded over a number of different securities, including currencies, commodities, and for our purposes here, indexes. Whilst the binary option contract is not specifically on the SPY and therefore not strictly Spider Options Trading, nevertheless, it is on the S&P500 index itself. But the outcome is the same and is worth mentioning here as an alternative approach for those who like to keep things simple.

spider options trading

QQQ Option Trading

Why I Like QQQ Option Trading and Some Favorite Strategies That Traders Can Use

QQQ option trading is simply about using the exchange-traded fund (ETF) commonly known as the QQQ (or ‘the Qs’) as the underlying financial instrument upon which you base your option trading strategies. The fund’s official name is the PowerShares QQQ Trust.

The QQQ is the most active of all the exchange-traded funds and is linked to the top 100 stocks in the Nasdaq Composite Index, known as the Nasdaq-100 (code NDX). It came into being in March 1999 and behaves just like a regular company stock, paying dividends and has options.

The advantage, however, of using an index related fund is that unlike individual company stocks whose price action can be dramatically affected by earnings reports or news items such as a change in management, product releases, disasters etc, an index generally absorbs the impact of these things because the price movement for one individual share is never significant enough to affect the whole index.

Only major economic news is likely to make a significant overnight difference to an index. Trading the QQQ is a cheaper alternative to trading the NDX directly.

This being the case QQQ options trading is not only highly liquid which makes it easy to get trades filled, but also a safer alternative since its price movements are smoother and less likely to experience overnight gapping. This makes the QQQ an ideal options trading vehicle. You can even take positions in it to hedge or balance your existing portfolio of options positions, particularly as expiration dates for short positions draw near.

QQQ Call Credit Spread Risk Graph

A Favourite QQQ Option Trading Strategy

The QQQ is known to be a highly volatile ETF because the Nasdaq-100 includes a heavy weighting of tech stocks such as Microsoft, Apple, Intel, Oracle and Google. The second highest component is the health care industry where price action can also be highly volatile due to their sensitivity to news items such as FDA product approvals or otherwise. As such, it can provide good setups for option straddle trading, or even better – the Victory Spread.

You simply wait till the price has run up or down to a support or resistance level and as long as the options implied volatility is not too high, analyze the risk graph and if you can see potential, place your long-dated straddle or strangle trade, set your ‘good till cancelled’ exit levels and prepare to take profits when price action has moved in accordance with your strategy.

For example, when one side has enough profit to cover the cost of the other, you take profit and now have a ‘free trade’ on the other side. Or you may simply wish to wait for an overall position profit level.

If you have enough funds, another QQQ option trading strategy can be set up using a QQQ straddle position with a near month expiration date along with ‘gamma scalping’ techniques where you go long or short the actual QQQ shares to keep it delta neutral until the expiration date. This strategy is one of many taught in the popular Trading Pro System series of videos.

There are even services out there such as OneQTrades.com which are specifically set up to provide trade recommendations for only QQQ related products. These include QQQ option trading signals. Some also advertise covered call services based on the QQQQ.

In summary, QQQ option trading can provide some exciting possibilities for the serious trader due to its liquidity and volatility. However, as any good options trader knows, it’s not wise to put all your eggs into one basket.

qqq options trading