The Standard & Poor’s 500 (S&P 500),  usually referred to as the SPX, is the largest stock market index, tracking the performance of the 500 largest companies listed on the US stock exchange. Due to its size, it serves as a benchmark for thousands of funds and fund managers. One-Signal also uses the S&P 500 as its reference index. 

While it is not possible to buy the index itself, there are several SPX trading possibilities, such as exchange-traded funds, futures, CFDs and options. Below, we outline how to trade the S&P 500 index using these instruments.

SPX trading with exchange-traded funds

An exchange-traded fund (ETF) is a security that tracks an index, sector, or commodity.  It can be bought and sold on a stock exchange in the same way a regular stock can. An ETF can be designed to track anything from the price of a single commodity to a large and diverse group of securities. 

One of the most traded S&P 500 ETFs is the SPDR S&P 500 ETF. This investment vehicle fully replicates the S&P 500 and generates returns that are roughly in line with the S&P 500 index (before expenses). This means that buying a share of the ETF equals buying a unit of the current holdings, representing a small portion of each stock of the S&P 500. As the units are traded on an exchange, the unit’s price may not always reflect the underlying value of the holdings. By looking up the symbol “SPY.NV,” traders can see the true value of one SPY unit, which is updated each morning (NV stands for “net asset value”). 

Investors using ETFs for SPX trading can short sell an ETF, buy it on margin, and trade it, just like any other stock on an exchange. Buyers and sellers may push the price above or below the true value of the underlying holdings in times of euphoria or fear. 

Advantages and disadvantages of trading with ETFs

Advantages of trading ETFs include:

• Trade like a stock: ETFs can be purchased on margin, sold short, and allow you to manage risk by trading futures and options. They can also be bought and sold like stocks on an exchange throughout the trading day.
• Reinvested dividends: The dividends of the companies in an open-ended ETF are reinvested immediately.
• Low expense ratios: ETFs generally have lower expense ratios compared to actively managed funds, as they are passively managed and aim to track the performance of an index or asset class rather than trying to outperform it. 

While ETFs offer several advantages, there are also some potential drawbacks to consider, too, including:

• Higher costs than trading stocks: ETFs come with management fees.
• Tracking errors: ETFs aim to track the performance of a particular index or asset class, but they may not always exactly match the performance. This is known as a tracking error.

SPX trading with futures contracts

Futures contracts are a type of derivative agreement between two parties to buy or sell an underlying asset at a specified price on a specified date in the future. Futures contracts are traded on exchanges, and the price of the contract is determined by supply and demand. Regardless of the market price on the expiration date, the buyer or seller must conduct the transaction at the predetermined price.

The price of S&P 500 futures is calculated by multiplying the index’s value by $250. For example, if the S&P 500 is at 2,500, then the market value of a futures contract is 2,500 x $250, or $625,000. However, to open a position like this, investors must only put up a fraction of the contract value. This is the margin on a futures contract. 

Key concepts in futures trading

Before beginning to trade futures, a deep understanding of the following concepts is crucial:

• Leverage: Traders can control large positions with relatively small amounts of capital, meaning that a small move in the underlying index can result in significant gains or losses, as it amplifies both. 
• Margin requirements: A “maintenance margin” is the minimum amount of equity that an investor must maintain in the account while trading. 
• Liquidity: As buyers and sellers are always present in the futures markets, market orders can be placed quickly. This also means that prices do not fluctuate dramatically, especially for contracts nearing maturity. 

For example, a trader can have $50,000 in their brokerage account, and they can borrow another $25,000 in leverage and enter a trade worth $75,000 less any amount the broker requires they hold in abeyance, which acts as the margin in the account.

Advantages and disadvantages of trading with futures contracts

Advantages when using futures for SPX trading include:

• Indirect investment: One of the frequently touted advantages of trading S&P 500 futures is that each contract represents an immediate, indirect investment in the performance of the 500 stocks that comprise the S&P 500 Index. Investing in specific S&P index companies may not always be desirable for many investors. Depending on their price expectations for the future, investors can take long or short positions.
• Liquidity: Because buyers and sellers are always present in the futures markets, market orders can be placed quickly. This also means that prices do not fluctuate dramatically, even for contracts nearing maturity.
• Extended trading hours: Many future markets trade outside of traditional market hours. Extended trading in stock index futures often occurs overnight, with some futures markets operating 24 hours a day, seven days a week.
• Low commissions: Future trade commissions are very low and are charged when the position is closed. Typically, the total brokerage or commission is as low as 0.5 percent of the contract value. 
• Trading long or short with equal ease: There is the possibility to short-sell using future contracts, which cannot always be done with all stocks due to different regulations or difficulties in borrowing the stocks. 

Disadvantages of futures trading include:

• Leverage: While trading on margin means that potential profits are magnified, it is important to remember that it can be a double-edged sword and that losses are magnified as well.
• Complicated products: Futures contracts can be challenging to understand for new traders, due to margin calculations and the use of leverage. 
• Large deposits: Futures contracts are for large amounts of the underlying commodity or instrument. Even though the margin requirement is a small percentage of the contract value, the dollar amount can be large for new investors.
• Expiration dates: Future contracts have an expiration date. As the expiration date approaches, the contracted prices for the given assets may become less appealing. As a result, a futures contract may sometimes expire as a worthless investment.

SPX trading with contracts for difference

A contract for difference (CFD) is a contract in which two parties agree to trade financial instruments based on the price difference between the entry and closing prices. If the closing trade price is higher than the opening price, the seller will pay the difference, which is the buyer’s profit. The contrary also applies.

Unlike stocks, bonds, and other financial instruments, which require traders to physically own the securities, CFD traders do not own any tangible asset. Just like futures, CFDs can also be traded on margin, so traders instead trade on margin with units that are attached to the price of a given security based on its market value.

Terms related to CFD trading that SPX traders need to know include:

• Spread: This refers to the difference between the buying and selling prices. 
• Holding costs: These are the charges that a trader may incur at the end of the trading day on open positions. Depending on the direction of the spread, they are either positive or negative charges.
• Commission charges: These are fees that CFD brokers frequently charge for trading shares.

Advantages and disadvantages of trading with CFDs

Advantages when trading SPX with CFDs include:

• Trading long or short with equal ease: CFDs enable SPX traders to profit from a falling market by taking advantage of share price declines. 
• Tradeable on margin: CFDs, just like futures, are leveraged products. Therefore, you only need to deposit a percentage (typically from 1%-10%) of the total value of the trade. This allows you to enhance returns and levels of market exposure.
• Low transaction costs: Brokerage using CFDs is usually more cost-efficient than buying shares through a full-service broker. Moreover, holding a CFD position is usually cheaper than a traditional purchase. 
• Ability to trade out-of-hours: Many providers offer extended hours. Individuals can trade some markets even after the SPX closes.
• No fixed contract size: Traders can buy and sell any number of instruments.

Disadvantages of trading SPX with CFDs include:

• Leverage: While trading on margin means that potential profits are magnified, it is important to remember that it can be a double-edged sword as losses are magnified as well. Even though SPX trading with leverage enables one to only deposit a certain part of the total amount traded, it is still possible to lose the initial margin and meet a margin call. When the latter happens, traders are forced to sell their assets and contribute more cash.
• Interest payable on the total transaction: Traders must pay interest on the total transaction market exposure, regardless of the margin contributed.
• Inflexible leverage levels: The CFD provider determines the margin level for each market, which the trader must have appropriate risk-management strategies for. The broker also has the right to increase the margin required mid-trade, meaning that the trader may be required to contribute additional funds.

SPX trading with options

Options are part of a larger class of securities known as derivatives. The price of a derivative is dependent on, or derived from, the price of another financial instrument.

An option is a contract that grants its holder the right, but not the obligation, to buy or sell an underlying asset at a specified strike price before or on a specified date. European options limit the execution to their expiration date. However, American options allow the holders to exercise the option rights at any time before and on the day of expiration.

Put and call options

 There are two types of options, namely “call” and “put” options. Call options give the option buyer the right to buy the underlying option at a specified price (the strike price) at a specified date, while put options let the option buyer sell the underlying option at a specified price, on a specified date. 

An easy way to think about call options is like a down payment on a future purchase. Put options, on the other hand, give the option buyer the right, but not the obligation, to sell the underlying asset or instrument at a specified price within a specific period. The strike price of the option is the price at which it can be exercised. 

Some examples: 

• Buying a call option: Buying a call option grants the owner the right to buy, for example, shares of a specific stock at a predetermined price later.
• Buying a put option: Purchasing a put option allows the owner to take a short position in the underlying asset. 
• Selling a call option: Selling a call option gives the owner a potential short position in the underlying asset. 
• Selling a put option: Selling a put gives the owner a potential long position in the underlying asset.

Key options terms SPX traders need to know

Terms related to options trading that traders need to know when trading SPX include:

• In-the-money (ITM): This  refers to an option that possesses intrinsic value. ITM thus indicates that an option has a value at a strike price that is favourable in comparison to the prevailing market price of the underlying asset. For call options, this means that the option holder can buy the security below its current market price. Regarding put options, it means that the option holder can sell the security above its market price. ITM options have higher premiums.
• At-the-money (ATM): This is a situation where an option’s strike price is identical to the current market price of the underlying security.
• Out-of-money (OTM): These are call options that have a strike price that is higher than the market price of the underlying asset. Conversely, an OTM put option has a strike price that is lower than the market price of the underlying asset.

Advantages and disadvantages of trading with options

 Advantages of trading SPX with options include: 

• Leverage: Options allow traders to control a large amount of a stock or other underlying asset with a relatively small investment. This leverage can increase the potential returns on investment, but it also increases the risk.
• Limited risk: The maximum loss for an option trader is the premium paid for the options. This contrasts with buying the underlying asset, where the potential loss is unlimited.

Disadvantages of trading SPX with options include: 

• Time decay: Options have an expiration date, and as the expiration date approaches, the options lose value at an increasing rate.
• Cost: Options trading is often more expensive than futures or stock trading, due to higher commissions. 

Summary

There are several ways of investing and gaining exposure in the S&P 500 index for traders to consider, thanks to the different possibilities available due to the sheer size of the index itself. These different instruments each have their own characteristics, advantages and disadvantages, meaning that each has something to offer every kind of trader, depending on their experience, risk tolerance, trading strategy and position size. All kinds of different investors, experienced, inexperienced, risk-averse, and risk-loving can find something that corresponds to them when considering SPX trading, making it an exciting avenue for potential trading success. 

One-Signal offers traders other means of ensuring trading success with our performance-backed, easy-to-understand daily trading signals. In the past decade, portfolios entirely based on One-Signal have returned an average of over 25% annually, in comparison to the S&P 500, which has returned roughly 7% over the same period. 

If you would like our insights on how to become a successful trader yourself, download our guide now. Alternatively, get in touch with our team for more information.