Index options are the most liquid options on the market, they don’t necessarily have the highest volume at all times but the liquidity is unmatched which makes it a very liked market and heavily traded.
The top index options that traders gravitate towards are: SPY (S&P 500 ETF), QQQ (Nasdaq ETF) & IWM (Russell 2000 ETF). They are in order from most heavily traded to least. The sheer volume and liquidity in these options mean that it’s easy to get in and out of the options for profits or even losses due to the small options spread.
For example, if you want to trade a weekly option on the SPY which would expire in a few days the spread will most likely not be more than $0.03 or $3 per contract. In comparison, we have the same expiry on an SQ(Square) contract that will be a lot more expensive but seeing a $0.20-0.60 spread is not out of the ordinary. Meaning that if you get in at a market order, the position will be at a loss by $20-$60 per contract and maybe even more.
Take a look at the image below comparing SQ and SPY options chains. We have SQ on the left and SPY on the right. The options expiration is the same, 3 days until expiry. However, you can see that the ATM spreads are vastly different the SQ spread is around $20-$30 while the SPY spread is $1-$2 per contract.
When do index options expire
Index options on SPY, QQQ, and IWM are really liquid as we’ve established so it’s a lot easier to trade, get in or out. That is not the only benefit as they trade differently from your regular stock options. All three of these index options trade until 4:15 each day which is after the regular trading day and the SPY actually has multiple weekly expiration dates.
Typically stocks & their options expire either monthly or weekly. There are a lot of stock options that expire on a weekly but not all. Meaning that each Friday the options expire. On the other hand, the SPY options have three total weekly expires. SPY options expire on Monday, Wednesday, and Friday. Meaning you have multiple different weekly options to trade to avoid theta burn if you’re day trading. This is a sign of ultimate liquidity.
These expirations on the SPY are great, I like to trade the SPY on a daily basis and that means that I have multiple different options in expiry selection.
Typically when trading regular stock options, on Thursday and Friday there is a worry that the options theta will burn out the position, causing traders to trade the more expensive options that are ITM or the next week’s expiry. When you trade the SPY on Thursday or Friday you can easily trade the next Monday expiry and not be too concerned with the theta burn and the damage it can cause.
That’s the same for any other day of the week. If we’re trading SPY on Monday, then I’ll opt for the Wednesday expiry. If I’m trading Tuesday I can trade Wednesday or Friday expiry.
That doesn’t hold true if you’re looking at the IWM and QQQ options. You either day trade the Friday expiries or you can trade the next Friday expiries.
All of these tips and tricks are useful for the day trading front rather than swing trading. Different rules would apply to swing trading.
How to trade index options
This is the golden question, how do we go about trading index options? When day trading any options, index or stock you will need a few key tools.
- A brokerage
- A charting system
- An order flow screener
- A trading plan!
Selecting a brokerage in options trading is easy, in the US you have a lot of different options. Either TOS or Interactive Brokers. The advantage of TOS (Think or Swim) is that they have commission-free trading. The platform is really easy to use and has chart software within, allowing traders to do everything through the platform.
Interactive Brokers on the other hand don’t have commission-free trading, however, the commission they offer is really cheap. The downside is the charting system is not great, in fact on the poor end, and has to be substituted with another platform like TradingView. Which does require an additional data subscription.
In Canada, if you want to find a good options broker, you can easily navigate towards Interactive Brokers and TradingView combined for the charting platform.
The second portion of learning how to trade the index options is a sound charting system. Mentioned before if you have TOS it’s not too necessary to have an external software system. At TPA we use TradingView a lot and manage our trades and trade from their charts. Whether it’s swing trading or day trading. TradingView has a lot of different components and customization features.
Another key tool for options trading and index trading it’s important to have an order flow tool that shows you what the big money is buying or selling. You can use this with the time and sales window. There are two main tools that we can use for order flow, either Flow Algo or Cheddar Flow. They provide the same information it’s up to which you would rather choose.
When reading order flow, you want to scan for either call or puts on your index options. SPY, QQQ, and IWM. When using Flow Algo, we want to make sure that we use the market structure and our technical analysis in conjunction with what we have seen in terms of flow. Here is a screenshot of Flow Algo.
If you see SPY calls, for example, it’s not necessary that you get into calls for a move up. There are criteria that you need to consider, where are you in terms of structure on the day? How big are the SPY calls, when they expire, and how they compare to the puts that have been coming in. If you want a debrief of the platform and how to use it.
Watch this tutorial video: Flow Algo
The final piece to the puzzle is the trading plan! How are you going to trade the index options? What do you need to know? Index options are very responsive to market structure and move well in trends and flow.
The key parts to the trading plan are:
- Your trading strategy
- Your risk management plan
Your trading strategy should identify when you are going to buy puts or calls. What chart you’re looking at (time-wise) and which tools/indicators you use.
Here is Victorio’s generic plan for day trading Index Options:
- Trade on the 10-min, 5-min, and 3-min chart
- Trade with pivot points
- Trading with the 20 EMA and 34/50 EMA cloud
- Long above 34/50 EMA on 10-min and Pivot point
- Short below the 34/50 EMA on the 10-min and Pivot Point
Take a look at the image above, we have 3 numbers.
- This is where the pivot point on the day is, below we have to look for the shorts, and we’re below the 34/50 EMA cloud which is very bearish, that doesn’t mean sell everywhere and anywhere. Rather it means to wait for the structure to pan out. There is some support that held out off the open.
- This is the s1 which is the next support, a viable attempt for the longs where you can grab a piece for an attempted move back to pivot but rage positions off fast, and don’t expect too much bullishness. This is where were above all EMA as well. Under this level and the session lows, we transition to the downside.
- Structure really bearish at this point, holding resistance with our EMA and the s2 support area now and market structure resistance level.
You also need to identify your options selection! It’s not enough just to have the charts up and say any option will do. Rather consider which expiry your trading, specifically on SPY which expires 3 times a week.
The closer you are to the expiry, the closer you want to be to the ATM or ITM options. If you are looking to trade options past Wednesday, highly consider going deeper ITM so the options premium doesn’t get eaten up by theta or directionless movement.
A good rule of thumb for options selection for index options is:
- If you’re trading SPY always give yourself 1-2 days of time minimum.
- Trade the 25+ Delta options
- Trade options that cost between $0.80 and $2.00. Don’t go too much above that.
- Cut risk at 20% loss of premium
- Take profit at 30+% gain of premium.
- Trade what you see not your bias.
Trading index options whether it’s IWM, QQQ, or SPY you want to create a trading plan and risk management plan. You should be aware of how much you are risking per trade and how much you stand to gain. Trade these with structure and a deep understanding of options.
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO AcademyTM is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.