How SPX Settlement Prices Can Screw Up Your Options

Trading is great if you like to stare. When you have a position on, sometimes you can't help but stare at the trading screen. Sure, if you have some options on that have weeks until expiration and they're not moving around very much, you stare at something else. Like TV. But fast-forward to expiration, and you can't pry your eyes away from the monitor with a crowbar.

One of the most interesting things to watch if you're an old index options trader like me is the settlement price of the S&P 500 Index (SPX). As you probably know, SPX options stop trading on the Thursday before the third Saturday of the month, and the SPX settlement price, which determines if the options are in- or out-of-the-money, is determined on Friday morning. If you have expiring SPX options, you have to wait and see what happens from the close on Thursday to the open on Friday. And you wonder why I have a few gray hairs? Anything can happen overnight!

What You See Isn't What You Get

So you wake up extra early on Friday and watch the S&P 500 futures to see whether there was a big move overnight. And you stare really hard at the SPX price at 8:30 a.m. CT to see how your positions might fare. The opening price of the SPX looks good for your positions, but only a rookie would breathe a sigh of relief. You see, even though the settlement price of the SPX is determined by the opening price, it's really the composite of all the opening prices of all 500 stocks in the index. That means the settlement price of the SPX can be significantly different from the opening price of the SPX itself. So what gives?

The SPX quote you see is the weighted average of all the last prices of the 500 component stocks. If a stock changes price, the SPX price changes a little, too. While most of the 500 stocks are trading pretty actively in the middle of the trading day, that's not necessarily the case at 8:30 a.m. CT in the morning. Just before the open, the price of the SPX is being calculated off the last prices of the 500 component stocks from the night before. At 8:30, some, but not all, the stocks start trading, and the SPX starts to change. The open price you see for the SPX is based on some current and some old data. The current data is for the stocks that are trading at 8:30. The old data is for the stocks that haven't traded yet, and is from yesterday's close. That's crucial because the settlement price of the SPX can be determined only when all 500 stocks have traded with an opening price. As I said, some have their opening price at 8:30, but others might not open until 8:45. If the overall market moves in those 15 minutes, the SPX settlement price has some of its data from before the move and some from after the move.

Because you have to wait until all 500 component stocks have opening prices, you won't know what the settlement price of the SPX will be until a couple hours after the open. That gives the exchanges time to verify the opening prices, calculate the settlement price, double-check it, and then broadcast it to the world under the symbol SET. The NDX and RUT settlement prices can take even longer.

Generally, if I have any expiring short out-of-the-money options in the SPX, for example, I'll try to close those positions before they stop trading on Thursday. Too much can happen in a market between Thursday night and Friday morning. Because the index settlement price can be such a wild card, to me, it's not worth taking the risk leaving those positions open.

And the gray hair? Nah, it's just a little powdered sugar.