In the final installment of the Iron Condor Course, we will be looking at whether it is better to trade Indexes or ETF’s.
COMMISSIONS
This is the big one for me.
If you have a broker (such as IB) who charge per contract, then it makes much more sense to trade the index options.
SPY is basically one tenth of the value of SPX, and as such you would need to trade 10 contracts of SPY to have the same exposure as trading 1 contract of SPX.
This adds a lot of commissions and thus for larger accounts makes index options more attractive.
As commissions vary across brokers this can lead to some variation on a broker-to-broker basis.
LIQUIDITY AND BID – ASK SPREADS
Liquidity is a huge consideration when trading Iron Condors.
Slippage can really eat into your profits, and it takes some practice and experience to get good fills.
Also, opening a trade is one thing.
Closing a trade when the market tanks and spreads widen, can be costly.
Traders who are worried about liquidity, or are just starting out, should stick to the ETFs as there will be less slippage.
When comparing liquidity on the major indexes, there is not much difference between index options and ETF options as both are very, very liquid.
Despite this there is usually slightly better liquidity on ETF’s.
Both index and ETF options have far better liquidity than single stock names making them far superior choices in terms of minimizing the transaction cost of Iron Condor’s.
As a side note, liquidity should also be a consideration when determining which instrument to trade.
For example, the CBOE has a monopoly on SPX options, whereas RUT is traded on multiple exchanges.
Multiple exchanges mean more competition amongst the market markers.
This translates to better liquidity for us.
From personal experience, I have always found fills much easier on RUT.
TAX
Indexes have preferential tax treatment and as such may be more suitable for larger traders. Income from index options is treated as 60% long term and 40% short term, regardless of the trade duration.
Income from ETF options is treated the same as stock.
As most Iron Condors are short term trades of between 15 and 60 days, index options will be more advantageous from a tax perspective.
CAPITAL LEVEL
The SPY ETF is approximately one tenth 1/10 the value of the SPX Index.
Those with a smaller capital balance may be better off trading SPY, as trading SPX may mean their capital at risk is too high.
DIVIDENDS
While not a huge consideration, ETF’s pay dividends while index’s do not.
When an ETF goes ex-dividend, the price usually drops by the amount of the dividend.
This is something that you may need to take into consideration when selecting your strikes.
ETF traders would also need to keep an eye on this close to expiration due to early assignment risk as discussed previously.
That concludes the 10 Part Iron Condor Course brought to you by Options Trading IQ.
I wish you every success with your trading. Did you enjoy the course?
Is there anything else you want to learn about iron condors or other option income strategies?
Feel free to drop me a line any time, I absolutely love hearing from my readers.
Gavin McMaster
Options Trading IQ