Trading Index Options
Index options are cash settled. This means that there is no underlying stock to deliver or take delivery of. Instead you receive the cash value of the Index at settlement. This is only if you decide to exercise.
Index options are expensive! Since many indices are values in the triple or quadruple range, this means the options will be expensive. For example take a look at options on the Nasdaq (NDX) Front month ATM'zzz.....
NDY AF Bid 38.00 X Ask 38.40 (Delayed Quote)
Yikes! Purchasing a contract is like paying your mortgage. These contracts are very expensive, and require very strict risk management principles, unless your comfortable going all in on one of these.
There is a substantial amount of leverage trading Index options, in fact this is the biggest leverage you can get out of options, and this is why they are so heavilly traded. Some of the more popular vehicles would be the SPX, NDX, DJX, RUT...and other industry specific indices like OIX, XAU, SOX, etc. Or perhaps you don't want that much leverage? Try the Mini's! MNX, XSP, RMN, or DJX (not relly a mini, but a smaller value than the underlying index). This gives you the capability to track the underlying index, not at the same pace, but at a better pace than an ETF option (QQQQ, DIA, SPY, etc.).
I guess the next best item to cover would be strategy. I find these products bode real well with spread traders. For me personally as a directional trader, I have traded directionally with index options, but only when it is obvious to do so. For example, in a trending market like we have experienced over the last several months this is a great time to trade index options. However, I would prefer just trading the futures contract instead.
Looking at that option premium, and how expensive it is, we could say at such a high premium it would make more sense to be a seller (as long as you do not expect big directional movements!). Like I said earlier, these are great vehicles for high probability spread trades. Verticals, Butterflies, Iron Condors, etc. Occasionally I will trade spreads on the indicies, even though I hate to admit it, but normally only in a bearish environment where I can trade call spreads. Since the market tends to correct, I prefer to sell calls than puts. Plus, calls are priced higher than puts which makes more sense.
The market is one of the hardest vehicles to predict directional movement in, so I suggest that if you are going to trade an Index, do it with a non-directional trade like some of the spreads I mentioned. I also would suggest starting small. Try a mini index first, and work your way up. For example, if the market starts to break support levels, lets try an index spread as a group activity.
Anyone out there title themselves as an Index Option trader? Any insights you would like to contribute or strategies you find that work well?
Hi Jeff... I heard you mention some interest in the new movie "The Pursuit of Happyness". I saw it yesterday and it was AWESOME! (bring plenty of tissues, even the men were sniffling). A definite "feel good" movie.
Posted by Anonymous | 12/19/2006 02:38:00 PM
Jeff....In your Trading Index Options post you said "The market is one of the hardest vehicles to predict directional movement in, so I suggest that if you are going to trade an Index, do it with a non-directional trade like some of the spreads I mentioned." Do you feel that stocks have a greater predictability in movement over indexes, mini's or ETF's? I have taken some of my worse losses due to news, M&A announcements, analyst upgrades/downgrades or sympathy news from another company. It seems that if you have 30, 500 or 2000 stocks in an index or tracked by an ETF you are less susceptible to adverse price movement. Am I missing something? Thanks for your input.
Doug
Posted by Anonymous | 12/19/2006 03:49:00 PM
Toni,
Thanks, I did want to see that sometime this week. I have heard nothing but good things...
Doug,
In my experience, trying to take short term directional trades on these, the market can move all over the place intra-day. Combine this with economic reports, and general news sensitivity, I have worse experiences trying to trade the market as a whole, than I do trading one small insignificant piece of it.
my .02 ~ Jeff
Posted by Option Addict | 12/19/2006 03:57:00 PM
Jeff....could not find the Mini's! MNX, XSP, RMN, or DJX on the tool box.
Chuck S
Posted by Anonymous | 12/19/2006 05:57:00 PM
Chuck,
Use $MNX instead of MNX. But the other symbols (XSP,RMN) are not up in the new tool box yet.
raaj
Posted by Anonymous | 12/19/2006 06:05:00 PM
thanks for the post. I would love to practice a trade as a group. I've been paper trading the SPX trying to get a feel for it. The intra day movement is huge,but I love the leverage. It's like riding a rollercoaster.
Sarah
P.S. have a great vacation.
Posted by Anonymous | 12/20/2006 07:26:00 AM
I have followed the spx very closely for 6 months, and feel that I may be able to day trade it. But, I am can not watch the market all day, so I just don't. I am not familiar with futures, but I heard that the SEC is going to change the margin requirement for options, making it similar to futures (risk based), so eventually this will catch to retail accounts.
Rodrigo
Posted by Anonymous | 12/20/2006 10:29:00 AM
Jeff, et al,
IWM (Russell 2000 EFT) currently has tradable options for *December*. On thinkorswim they are listed as DEC5 and show 8 trading days remaining.
What are those options?
Thanks,
Posted by Mike | 12/20/2006 02:20:00 PM
I frequently day trade the NDX. Among all available indexes, I choose the NDX because it moves a lot during the day and the spreads are not too large.
I follow the stochastic on the 1 minute and 5 minutes chart. I buy when it's in oversold or overbought zone, unfortunately it could stay a long time in either one or the other, I also use pivot points, support and resistance.
This morning I bought the January 1800 put at 9:08 for 31.80, I sold it at 10:31 for 36.40.
I bought the jan 1800 again at 12:45 at 34.90 and sold it for 36.80 at 1:02.
Today was a great day. I recomend to paper trade this before trading with reel money and always use a stop loosses since it could change direction very fast.
Janine
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