How to Trade SPY Options

Trading stocks allows you to capitalize on price fluctuations and long-term trends to realize profits. Some people happily buy and sell stocks, but others seek options trading as a way to potentially increase returns and explore more opportunities.

You can trade options for individual stocks and funds, but few of them have the same appeal as SPY options. SPY options have incredible liquidity and attract beginners and experts alike. Here's how to start trading SPY options and some things to keep in mind as you get started.

What Are SPY Options?

SPY options are derivatives that give you exposure to SPY, an exchange-traded fund (ETF) that mirrors the S&P 500. The diverse range of stocks in the fund makes it a popular way to achieve market performance. Options traders don’t have to worry about picking an outlier that zigs when the market zags if they trade SPY options.

How to Trade SPY Options in 3 Steps

Getting set up to trade SPY options is a straightforward process you can do with many brokerage firms. You can follow these steps to enable SPY options trading on your account.

Choose a Brokerage

Each brokerage gives its investors different perks and capabilities. Some brokerages make it easier to trade options, while others offer discounts on fees. Traders should compare several options trading brokers to see which one is the best for their needs.

Register Your Account

After you have chosen a brokerage, the next step is to create an account and complete the onboarding process. Each brokerage firm requires basic information such as your name, email, address and other details. 

Fund Your Account

The final step is to fund your account by connecting one of your bank accounts. You can conduct electronic transfers and use the incoming cash to trade stocks. Options traders have to apply for the right to trade options and get assigned a level. You can trade SPY options if you are a Level 2 options trader and get access to most of the options trading strategies if you become a Level 3 options trader.

5 Trading Strategies to Consider for SPY Options

What happens once you can trade SPY option calls and puts? Instead of rushing into options trading, you should assess your portfolio goals to see which options trading strategies make the most sense. These are some SPY trading strategies to consider.

Credit Spread

For a credit spread, an options trader buys and sells one contract of the same type, security and expiration. The only difference between the two contracts is the strike prices of the options.

The premium from the sold option exceeds the premium from the purchased option, resulting in a net credit. This strategy lets you profit if the stock stays within a price range while limiting your losses. 

A bearish SPY trader can apply a credit spread by purchasing a SPY call with a $410 strike price and selling a SPY call with a $400 strike price. Because the expiration dates are the same, the SPY $400 call will have a higher premium than the SPY $410 call, resulting in a net premium.

A bullish SPY trader can apply this concept with puts. The trader can sell a $390 put and use some of those proceeds to purchase a $380 put. The further out of the money an option is, the lower the premium. Because a $380 put is further out of the money than a $390 put, the trader nets a profit. This profit limits their downside but exposes them to more gains if SPY falls below $380 per share.

Iron Condor

An iron condor setup has a call credit spread and put credit spread. All four options have the same expiration dates but different strike prices. Traders will realize the maximum profit if they sell a call and put at the money but also risk more downside if the stock moves unfavorably.

The maximum gain for any iron condor is the premiums you receive at the beginning of the trade. The maximum loss is the difference between the bought and sold strike prices of the calls and puts minus the net premium. Traders can limit their gains and losses based on the strike prices they choose for each call and put. 

Long Strangle

A long strangle involves buying one call and one put that are both out of the money. The maximum loss from a strangle is the combined premiums of the call and put, but the maximum gain is unlimited. Traders who use strangles hope that the stock’s price will move sharply in either direction. They buy options with different strike prices but the same expiration date.

If you buy a SPY $420 call and a SPY $380 put, you will make a profit if SPY falls well below $380 per share or rises well above $420 per share. The long strangle means you don’t have to guess which direction SPY will go. You can profit from a sharp movement in either direction, but you will realize the maximum loss if SPY moves sideways.

Straddle

A straddle is similar to a strangle. To set up a straddle, you have to buy a call and a put with the same expiration date. The key difference is that the call and put in a straddle also have the same strike price. While you can set up a strangle with a SPY $420 call and a SPY $380 put, you can set up a straddle with a SPY $400 call and a SPY $400 put. If these strike prices are different, it is no longer a straddle and is a strangle instead.

Iron Butterfly

An iron butterfly is a short straddle with a long call and long put to protect you from unlimited losses. The long put and call are necessary for this position because there is no limit to how much you can lose from a short straddle that goes wrong.

Assume SPY trades at $410 per share, and you initiate a short strangle by selling a call and put that both have $400 strike prices. A trader may purchase a call with a $410 strike price and a put with a $390 strike price to protect themselves from unlimited losses. All four options have the same expiration date, but there are only three different strike prices.

The trader realizes the maximum profit if the stock’s price goes sideways and stays within a small range. The maximum loss a trader can incur is the gap between the strike prices of one of the options types minus the net premium. 

If the stock declines, the gap between the short and long put strike prices minus the net premium represents the net loss. If the stock rises, the gap between the short and long call strike prices minus the net premium represents the net loss.

5 Things You Should Know About Trading SPY Options

Knowing various options trading strategies can guide better trading decisions based on how you predict SPY will move in the upcoming days, weeks and months. You can limit your risk and give yourself opportunities to profit from SPY price fluctuations. But there are still a few more things you should know before you start trading SPY options. Here are five things you should keep in mind.

Trading Hours

SPY options have different trading hours from the regular stock market. While the stock market opens at 9:30 a.m. ET and closes at 4 p.m. ET,  you can trade SPY options from 9:15 a.m. ET to 4:15 p.m. ET. You have 15-minute buffers at the start and close to do some extra trading. 

Trading Costs

Trading costs depend on your broker, and it’s something you should examine before deciding which broker to use. Some brokers charge a flat fee for each option contract, while other brokers charge a flat fee for every order. 

Assume Broker A charges a 65-cent fee for every options contract traded, while Broker B charges a $5 flat fee for every options order. If you buy one call, you pay 65 cents to initiate the position with Broker A compared to a $5 fee with Broker B.

An options trader may want to initiate five SPY iron condors. Each iron condor requires four options contracts, which means 20 contracts in total. Because Broker A has a 65-cent fee for every contract, the total cost comes to $13 just to open the iron condors. You will have to pay another $13 to close all five iron condors unless you let them expire on their own.

Broker A has a one-way $13 fee for this trade, while Broker B only charges a flat rate of $5 per order. Whether you trade one contract or 20 contracts, the $5 flat rate stands. It only costs $10 with Broker B to get in and out of five SPY iron condors instead of $26 with the other broker.

Options Expiration

Every option has an expiration date that determines the contract’s value and how much time you have to make a profit. A longer expiration date gives you more time for your thesis to play out, but it also results in a higher premium. Options set to expire in a few days have the lowest premiums because the option’s time value has significantly decreased. This phenomenon is known as theta decay. 

Liquidity

Liquidity impacts your ability to quickly enter and exit trades. High liquidity is beneficial because you can transition to new positions and won’t have to worry about a wide bid-ask spread. SPY options happen to be the most liquid options, so if you want to buy contracts, there’s a seller ready to go on the other side.

Taxation

The profits from SPY options get treated as short-term capital gains. This treatment results in a higher tax rate on your gains, depending on how much taxable income you earn. Short-term capital gains get taxed at the same rate as your ordinary income.

Possible Advantages of Trading SPY Options

Trading SPY options can present several advantages to options traders who are getting started or have a few years under their belt.

• High liquidity: You won’t have to worry about wide bid-ask ranges or getting stuck with positions you can’t exit.
• SPY mirrors the S&P 500: If you trade options of individual stocks, you can get caught up in company-specific news. Trading the S&P 500 makes your returns more in tune with how the stock market performs rather than a specific asset.
• SPY contracts have more expiration dates: Most options only have Friday expiration dates. If you trade SPY, you can buy and sell options that expire on any weekday as long as the market is open.

Risks of Trading SPY Options

Every investment opportunity comes with risks. Below are some things to keep in mind before allocating funds to SPY options.

• Options can expire worthless: If you buy a SPY call, and SPY proceeds to trade sideways and gradually decrease, the call will eventually expire worthless.
• Options trading strategies often limit your upside: While these same strategies can mitigate risk, you also put a limit on your gains with trading strategies like iron condors and iron butterflies. Each trader has to consider how much they want to gain and what level of risk they are willing to take on for those gains.
• SPY options can get exercised before the expiration date: If you sell a put that becomes in the money, you will have to buy 100 shares of SPY at the expiration date. However, the contract holder can decide to exercise the put before it expires, resulting in you having to buy 100 SPY shares sooner. You can buy a put and create a spread to minimize this risk.

Frequently Asked Questions