SPX Options Undergo a Metamorphosis

Changing SET settlement a good step for traders

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As a long-time Chicago Board Options Exchange (NASDAQ: CBOE) market maker, I’ve been very disappointed in how my ‘home’ exchange has handled S&P 500 Index Options (CBOE: SPX). The exchange applied some trading rules to the SPX that didn’t work for me and many other customers, but that was their right. Apparently their decision did not hurt business because SPX is a trading vehicle with world-wide support and fantastic trading volume. This topic – settlement of the SPX options at expiration – is something that touches many options trading investors.

Nevertheless, change is in the air and I love it. In fact, I plan to switch from trading the more volatile Russell 2000 (CBOE: RUT) options to trading SPX options, once the changes described below apply to all SPX options.

Goodbye (almost) to morning Settled SPX Options

In early December, the CBOE quietly transformed its Weeklys SPX options from morning settlement to afternoon settlement. That’s good news to me. I had always felt that morning settlement was simply too confusing for the individual investor who somehow could never quite grasp how the final settlement price was determined. It was not complicated, but it was never logical.

Here’s how it has worked –

When SET, the settlement price (the SPX value that determines the value of all in-the-money options) is the true closing price for the day, there is no confusion. Everyone sees the current SPX value as it changes throughout the day. There are no surprises at day’s end.

However, morning settlement is very different. To calculate SET, the index was calculated as if each of the 500 stocks in the index were trading at its individual opening price for the day — simultaneously. This is an imaginary number. All stocks do not open at the same time.

For instance, if there is buying pressure at the opening, buyers exceed sellers and the opening price of each stock is relatively high, though it usually reverses direction when the buying pressure disappears. However, it is only that initial ‘high’ opening price that is used to determine SET. Thus, SET is skewed because most stocks open with that buying pressure.

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Article printed from InvestorPlace Media, http://investorplace.com/2011/03/spx-options-quietly-undergo-a-metamorphosis-spx-rut-cboe/.

©2014 InvestorPlace Media, LLC

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