SPX and S&P 500 futures don’t always move up and down together. Which one should you look at if you want to know what the market might be doing?
Back when “the market” was just stocks, some genius came up with a way to figure out what all the stocks (at least the popular ones) might be doing overall. Behold, the equity index! Whether it’s price-weighted like the Dow Jones Industrial Average, or capitalization-weighted like the S&P 500, an index is just an average of stock prices. And when the stock prices change, the index value changes. Simple—and useful.
Indices turned out to be popular, and they spawned all sorts of products like index options and index futures. Those are handy when you want to speculate on an index’s direction. Fire up your thinkorswim® platform from TD Ameritrade and have a look.You might have /ES (the S&P 500 future) and SPX (the index on the S&P 500) loaded up on a watchlist. Because they’re both based on the S&P 500 index, you figure when one moves up, the other should, too, by the same amount. But they don’t—at least, not always. How come?
There are 500 individual stocks that make up the SPX. Many of these stocks may trade actively, with transactions occurring every second. Others may trade less frequently—every few seconds, or few minutes. Here’s where it gets interesting. The SPX changes when the last trade price of any component stock changes. Meanwhile, the stock’s bid and ask prices might be above or below the last trade price, and more accurately reflect its current value. But until that stock trades, the SPX’s value doesn’t change. So, it doesn’t necessarily reflect the current value of all 500 stocks. The SPX, then, is a snapshot of the last trade prices.
The /ES future, on the other hand, is its own product, and isn’t tied directly to the S&P 500 stocks. That means the value of /ES is determined by buyers and sellers of the futures contract. If traders think the S&P 500 will rally, they’ll buy /ES and drive its price up. The price of /ES doesn’t have to wait until all 500 stocks trade. If /ES traders think a stock that hasn’t traded yet has a higher or lower price, they’ll adjust their /ES trades accordingly. When traders look for arbitrages between /ES and basket of 500 stocks, they look at the bid and ask prices of the stocks, and not their last trade prices.
This is why SPX and /ES don’t always move up and down together, tick by tick: the SPX changes only when one of its stocks trades, but /ES can change anytime. The arb relationship means when one makes a big move up or down, the other does, too. But when there isn’t much movement in the market, you may see /ES move up and down more actively than SPX. You may also see /ES move up or down quickly, and then a few seconds or minutes later, SPX catches up. And this is important if you’re trading SPX options, because SPX options are priced off /ES prior to expiration.
A trader who’s bullish on the S&P 500 might consider selling a put on the SPX options. Say you’re looking at a particular put, and notice SPX hasn’t changed, but the put’s price has dropped. Why? Possibly because the “market” believes the S&P 500 might go up and is pushing up the price of /ES. But all stocks in the SPX haven’t traded yet. That SPX put is looking at the /ES, not the SPX. And if you want to know what the market’s doing, you might consider looking at /ES, too.
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
The naked put strategy includes a high risk of purchasing the corresponding stock at the strike price when the market price of the stock will likely be lower. Naked option strategies involve the highest amount of risk and are only appropriate for traders with the highest risk tolerance.
Options on futures are not suitable for all clients and the risk of loss in trading futures and options on futures could be substantial. Additionally some options expire prior to the final settlement or expiration of the underlying futures contract. Option writing as an investment is absolutely inappropriate for anyone who does not fully understand the nature and extent of the risks involved and who cannot afford the possibility of a potentially unlimited loss. It is also possible in a market where prices are changing rapidly that an option writer may have no ability to control the extent of losses.
Thomas Preston is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.