The SPX Size Advantage

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September 18, 2013

Presented by Marty Kearney

@MartyKearney

SPX

(SM)

_{vs. SPY Advantage Series- Part II}

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CBOE OPTIONS INSTITUTE 2

Disclosures

Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, by calling 1-888-OPTIONS, or at www.theocc.com. The information in this presentation is provided solely for general education and information

purposes. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes. In order to simplify the computations,

commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Multiple-leg strategies involve multiple commission charges. No statement within the presentation should be construed as a

recommendation to buy or sell a security or to provide investment advice. CBOE, Chicago Board Options Exchange, CBOE Volatility Index, OEX, VIX and XEO are registered trademarks and

Execute Success, Quarterlys, SKEW, SPX, SPXpm, The Options Institute, Weeklys and XSP are service marks of Chicago Board Options Exchange, Incorporated (CBOE). S&P®, S&P100® and S&P 500® are trademarks of Standard & Poor’s Financial Services, LLC and have been licensed for use by CBOE. S&P does not sponsor, endorse, sell, or promote any S&P index-based investment product. All other trademarks and service marks are the property of their respective owners.

Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, SPXpm and XSP are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations.

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Presentation Outline

• Review: The Mechanics of Index Options

• Size of SPX versus SPY Option Contract

• Tax Considerations

• Example – Long Bullish Call Spread

• Smaller SPX – the XSP

• SPX Option Pricing

• Summary

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Mechanics of Index Options

SPX options function much like SPY (ETF) options

Both calls and puts are available for trading

There are several major differences:

• SPX options settle in cash, not in shares

• SPX options are European style

• Size of the contract

• A potential tax benefit exists for index option traders

Covered in Part I

yesterday

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The Cash Settlement Process

Example: SPX is 1638.53 at expiration

Cash Value of a 1600 Call?

SPX Value

1638.53

Less Strike Price

1600

Difference 38.53

x Multiplier

x $100

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Index Options - SPX

Ticker Symbol

SPX

Underlying

S&P 500 Stock Index

Multiplier

$100

Exercise Style

European

Settlement

AM

Full Contract Size 10 x SPY

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Potential Tax Advantage

of Index Options

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Index Options

Potential Tax Advantage

ETF Options

Broad Based Index Options

*Consult your tax advisor **According to Taxes and Investing, published by The Options Industry Council, available from

http://www.cboe.com/LearnCenter/RCGeneral.asp

Note: Under Section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, SPXpm and XSP, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations.

• Are treated like stock options*

• Receive 60-40 Tax Treatment**

• 1256 Contracts

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60-40 Tax Treatment - Example

You bought an SPX option Monday at $5.00.

Two days later you sell the option at $9.00.

Taxes are due on the $400 gain.

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60-40 Tax Treatment

1256 Contracts:

• All Profits treated as 60% long term / 40%

short term regardless of holding period

• Reported on Form 6781 and Schedule D

• Year end prices become cost basis for

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Index Options

Broad Based Index Options include:

• S&P 100 – OEX, XEO

• S&P 500 – SPX, SPXpm, XSP*

• CBOE Volatility Index - VIX

*

XSP is the 1/10 size Mini-SPX option contract, also

based on the Standard & Poor's 500 Stock Index. XSP

has most of the same features of SPX: Broad-Based,

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SPX Comparison to SPY

Contract Comparison

SPY is the SPDR S&P 500 ETF which

represents ownership in a portfolio of stocks

that replicates the S&P 500 Index.

The underlying pricing for both SPX and SPY

options is the S&P 500 Index

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SPX Comparison to SPY

Size Comparison

S&P 500 at 1640.00

1 SPY Option = $164 x 100 = $16,400

1 SPX Option = 1640.00 x $100 = $164,000

To control the same amount of market value, 10 SPY

contracts need to be traded for each SPX contract

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SPX Comparison to SPY

Contract Comparison Summary

S&P 500 at 1640.00

SPY

SPX

Underlying Value

164.00 1640.00

Contract Underlying

100 Shares

$100.00

American / European

American Style

European Style

AM / PM Style

PM

Both Available

Settlement

Buy / Sell Shares Pay / Receive Cash

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Trading Example

•

S&P 500 quoted at 1664.00

•

We have a bullish outlook over the next three

weeks and expect market to rally +2% to

1700.00 by quarter end (September 30

th

).

•

SPXQ options expire on last day of June,

September, December and March

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Long SPX Call Spread Example

•

S&P 500 at 1664.00

•

To trade this positive outlook for the S&P 500

we decide to do the following:

Buy 1 SPXQ (9/30/13) 1670 Call at 17.80

Sell 1 SPXQ (9/30/13) 1700 Call at 6.00

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Long SPX Call Spread

S&P 500 at 1664.00

Long SPXQ 1670 - 1700 Call Spread at $11.80

Breakeven:

1681.80 (1670 plus $11.80)

Risk:

$11.80

Potential gain:

$18.20

Difference in strikes ($30) less $11.80

premium paid = 18.20

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CBOE OPTIONS INSTITUTE 20 (20.00) (15.00) (10.00) (5.00) 0.00 5.00 10.00 15.00 20.00 1650 1661 1672 1683 1694 1705

Debit Spread

Long 1 SPX 9/30 1670 Call @ 17.80

Short 1 SPX 9/30 1700 Call @ 6.00

1670 & 1700 Calls

Expire OTM

1670 Call ITM

1700 Call OTM

1670 & 1700 Calls Both ITM

Current Price

1664

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Long SPX Bull Call Vertical Spread

Long 1 SPXQ 1670 – 1700 Call Spread at $11.80

Payoff Table

SPX at

Expiration

SPXQ

1670-1700 Spread Call Premium Profit / Loss

1640

1650

1660

1670

1680

1681.80

1690

1700

1710

(11.80)

(1.80)

- 0 -

8.20

18.20

0.00

10.00

11.80

20.00

30.00

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More SPX & SPY Differences

• SPY commission 10 contracts in and out

SPX commission 1 contracts in and out

• Tax consequences on gain:

SPX 1256 (60/40)

SPY tax status uncertain

• SPY position turns into SPY shares if not

closed, SPX settle in cash

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SPX & SPY Settlement

SPX at 1,664 goes to 1,694 at expiration

The SPX 1670 – 1700 spread now worth $2,400

SPX spread settles in cash, $2,400

A comparable SPY position (if not closed out

before expiration) turns into 1,000 SPY shares

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SPX Option Pricing

SPX October 1690 Call is $12.00 bid - $12.50 offer

SPY October 169 Call is $ 1.20 bid - $ 1.25 offer

Which option is more expensive?

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SPX Option Pricing

SPX options - usually more expensive than SPY?

Yes, but

they’re 10 X the size

An SPX October 1690 Call might show:

$12.00 bid – offered at $12.50

A SPY October 169 Call could be:

$1.20 bid, offered at $1.25

One would need to buy or sell 10 X the number

of contracts in SPY to equal each SPX contract

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Option Pricing – Comparing…

SPX October 1700 Call is $3.00 bid – $3.30 offer

SPY October 170 Call is $0.30 bid - $0.32 offer

Why wouldn’t they be the same?

SPY is AM settlement, SPX is PM

SPY volume greater (SPX notional value larger)

Quantities bid / offered on SPY could be small.

Same can be seen with XSP.

Marketmakers hedge in a variety of ways. Try

limit orders.

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Why SPX Options?

•

Larger notional size – potentially lower

commissions (10 to 1 ratio)

•

Convenience of cash settled options versus

physical delivery of shares

•

No potential early exercise issues with SPX

•

Preferred choice of sophisticated

institutional traders

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Summary

SPX Options are an excellent method of

gaining exposure to the S&P 500 Index

SPX Index options are eligible for 60/40 tax

treatment*

Three part forecast needed for option trades:

underlying / time / implied volatility

Spreads offer unique trade-offs

www.cboe.com/spx

*Note: Under Section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, SPXpm and XSP, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations.

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Additional Resources

At

www.cboe.com

go to the Index Micro-Site

http://www.cboe.com/micro/IndexSites.aspx

This site includes information on SPX, XSP,

SPXPM, as well as Dow Jones Indexes,

Russell Indexes, NASDAQ Indexes, VIX®,

Skew and Custom Indexes as well as Weekly

and Quarterly options.

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Archived Webinars

For additional webinars on SPX or other Index

products including VIX & credit spreads, go to:

Credit Spreads -

Weeklys(SM) Iron Condors -

http://accordent.powerstream.net/008/00124/presentations/CBOE20130509

The Holy Grail of Trading – Iron Condors:

http://accordent.powerstream.net/008/00124/presentations/DS20130514

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Additional Webinars

VIX and SPX -

First Quarter VIX Trading Review -

http://accordent.powerstream.net/008/00124/presentations/CBOE20130409

Trading Index Options: Popular Strategies for Today’s

Markets -

http://accordent.powerstream.net/008/00124/presentations/CBOE20130319

SPX vs SPY -

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Upcoming Seminars

New Trends in Trading VIX

Chicago, IL or Online – September 28, 2013

Options Profits, Option Pit and the Options Institute at CBOE are teaming up for a full day of education covering what is new in the world of trading options, futures and exchange-traded products on VIX and other volatility related markets and how VIX products can be utilized in this current low volatility environment.

Simply the Basics

Chicago, IL– October 30, 2013

Simply the Basics is a half-day seminar led by CBOE Options Institute instructors, Peter Lusk and Russell Rhoads, that helps you understand the basic concepts of options -- such as what are calls and puts, what are the factors that influence the price of options contracts and what makes values change?

Options Initiative- Level 1 Beginner

Chicago, IL or Online – December 2 & 3, 2013

This 2-day classroom experience plus 10 hours of distance coaching will introduce you to the basics of options and the basics of market timing, stock selection and risk management.