Drawing from a trove of experience and capital, many institutional investors mitigate the risks of “playing” options by engaging in market indices instead of individual stocks. The Russell 2000 Index (NYSE:RUT) and the Standard & Poor’s 500 Index (BZE: SPX) are two common indices, but not everybody is able to participate. In particular, retail traders with little capital typically cannot afford the option premiums on the indices and are, once more, left trailing after their larger counterparts. 

However, certain global exchange operators like Cboe Global Markets, Inc. (BATS:CBOE) have created tools to combat this disparity and provide more access to the retail trader. Adding to its list of market innovations, Cboe® has recently announced its Cboe Minis product line. At 1/10th the size of the standard contracts, the Mini-S&P 500 Index (XSPSM) and Mini-Russell 2000 (MRUTSM) Index options are set at a price that is meant to be more friendly for retail traders to easily participate in smaller versions of the SPX and RUT indices.

Aside from diversification and risk of early exercise, there are several technical reasons why a trader would invest in index options. The lower volatility on index options, for example, ensures there are fewer fluctuations to the valuation of a portfolio from catalysts like mergers, earning reports and others. Additionally, and importantly, index options often have much narrower bid-ask spreads than single-stock options. This high liquidity means that traders can buy and sell index options without the threat of transacting at a significantly different price than intended.

Trading index options may also come with tax benefits. According to Section 1256 of the tax code, those who choose to trade index options may qualify for 60% long-term, 40% short-term capital gains tax treatment given that certain conditions are met. Because of the nature of index options, they settle to cash instead of shares, and investors cannot exercise them before expiration. 

Readers should understand that the authors were compensated by Cboe for the preparation of this article, which is not intended to be used in connection with the offering for purchase or sale of any product. The information in this article is for informational purposes only and no statement within this article should be construed as investment advice or a recommendation to buy or sell a financial product. The authors and Cboe make no representation as to the appropriateness of XSP or MRUT options for any investor. Neither the authors nor Cboe assume any responsibility for any losses you might suffer by reason of investing in XSP or MRUT options.