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- Picking the Correct Tool for the Job
Good Morning!
This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!
Quote of the day:
"If all you have is a hammer, everything looks like a nail."
-Ron Jeremy
See, Ron was known for his hammer, and some may even say his hammering abilities... As a famous intellectual of sorts, he was quoting the "law of the hammer" as first noted by 20th century psychologist Abraham Maslow.
If you only have one tool or approach to solve a problem, you may be tempted to use it regardless of whether or not it is the most appropriate solution for the problem at hand. And in trading, you create A LOT of problems for yourself! And most of those problems can't be solved by averaging-in even more!!!
Today we are going to learn about the advantages of SPX options as a crucial tool in your belt when tackling a multitude of problems.
Each day this week will highlight a specific use case of SPX from the very classy portfolio hedging to the full-blown degeneracy of 0DTE options!
BANG for Your Buck:
| 1/9/2023 SPX = 3895.08 | Handles of Movement | 1-Day Implied % Move |
|---|---|---|
| BANG (intraday) | 52 | 1.3% |
| BANG (weekly) | 114 | 2.9% |
Remember, this is where option bookmakers are pricing potential underlying movement for today and for the rest of the week. For day trading, use the daily BANG to estimate the trading range for the day and act accordingly. Here's an example of how to do that.
In the coming week, this section will be beefed up with even more relevant and actionable data such as: weekly bang review, overnight expectations, gap probability analysis, and more! Believe it or not, the market just kinda tells you all this stuff, if you know where to look...
SPX Options
What are they?
SPX options, also known as S&P 500 options, are options contracts that are based on the value of the S&P 500 index.
The S&P 500 is considered a leading indicator of the overall performance of the U.S. stock market and is one of the most widely followed stock market indices in the world. This is the index that normies generally refer to as "the market" e.g. "I had a good day in the market", or "the market f*cked me today!"
SPX options give traders and investors the ability to speculate on the future direction of the stock market or to hedge their portfolios against potential market movements.
What is the advantage of SPX?
Liquidity: it's the most liquid gambli...er, I mean options market in the world
Flexibility: the market allows for complete creativity: multiple timeframe speculation, portfolio hedging, synthetic fixed income, insurance underwriting, insurance buying, etc.
Cash Settled / European Options: You never have to worry about being assigned the stock or exercising (well, you may want to exercise for you own health lol). So those annoying emails from TD Ameritrade warning you that you have "options expiring" yada yada yada...yeah just delete those!
Large Notional Size: Don't waste your time on baby contracts like SPY (also these are American and assignable into the ETF...mucho more peligroso) just trade the big dawgs!
Trading Hours: This casino only shuts down a couple hours a day to vacuum the carpets and re-stock the ATMs! So, during the Ukraine Invasion, you could have protected your portfolio at 10 o'clock at night, and not waited around like a rube for the 930a ET open!
60/40 Tax Treatment: This is not tax advice! Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX Options, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss. Taxation is probably your largest cost in trading, and these bastards figured out a way to reduce your burden to your favorite uncle, Sam.
Reduced Margin: If you actually own stonks, you can get a discount on SPX option margin because you're actually reducing risk (what a novel idea?!)
More details at the CBOE (pronounced see-bow)
Make Me a Better Trader
Let's say you think "the market" is going to sell off temporarily.
Option 1: Sell your stocks, and buy them back later
Disadvantages:
Tax consequences (we all know you didn't plan for any of that!)
You are now trying to "time the market"
Getting back in is much harder than it sounds (you will miss that bottom, and you'll sit on the sidelines watching and waiting, then probably buy a local top, then panic and chop yourself into pieces)
You need a different tool!
Option 2: Buy a Put Spread on SPY
You know SPY, you own it, you talk about it on r/wallstreetbets. Maybe because you're a Boglehead, or maybe you just believe that low cost "passive investments" are better than active trading (voicing your own opinion on a stock) and NOT a way to systematically extract 100s of billions of dollars through essentially algorithmic brokerage! (oh, don't get me started! at some point, we'll dive into the passive investment "revolution" and how it concentrates way too much power in the hands of a few investment sponsors that can exert control over publicly traded companies and essentially public policy)
The SPY options disadvantages
Small: 1/10 the notional size of SPX. You will need 10x more lots to achieve the same profit goal. This leads to more commissions
Assignable/Exercisable: you need to trade out of these before expiration, if in the money. This leads to more commissions
No Tax Benefit: c'mon man! This leads to losing more of your money
You should only use SPY if you actually want to get assigned the ETF!
Option 3: Buy a Put Spread on SPX
Welcome home, my boy!
You ain't touching your stocks!
You're using cash settled options with no pin / assignment risk!
You don't need to trade a lot of size, so your commissions are low!
The bid/ask spread is tighter than a duck's ass, also reducing your transaction cost!
Even though this trade may be short term, it can be treated 60% long term gain for tax purposes!