It wasn’t the easiest start to the week. Stocks dropped Monday as oil prices surged following the attack on Saudi Arabian oil facilities over the weekend.
As I fired up my trading screens early Monday morning, the indicators that I rely on heavily in the premarket were all over the place. That made it tough to get a clear read on which direction I would choose for the Trade Of The Day.
The alert, which I send to traders 30 minutes prior to the market open, contains the option’s strike price, expiration date and, of course, whether it is a call option or a put option. The ability to easily profit from both bullish and bearish moves is one of the main benefits of trading options over stocks.
And one way I gain an edge in the options market is by trading the same security day in and day out. By doing so, I have become intimately familiar with how it trades, how it responds to key levels and what patterns work best.
In fact, you could say I’ve become somewhat of a guru on this particular security…
SPDR S&P 500 ETF (SPY) is the highly liquid ETF that tracks the S&P 500.
The S&P 500 is considered to be a representation of the broader market, as it tracks the stocks of 500 large-cap U.S. companies.
SPY isn’t the only ETF that tracks the companies in S&P 500 though. In 2003, the S&P 500 Equal Weight Index was created. As you probably guessed, this is a version of the S&P 500 index in which every company is given equal weight regardless of its market cap.
The traditional S&P 500, on the other hand, is a market capitalization-weighted index, meaning that the companies that have the largest market caps will have the greatest weight in the index.
Because of the way they are constructed, the S&P 500 and S&P 500 EWI have different amounts of sector/stock exposure, and, thus, perform differently.
SPY is the most popular ETF that tracks the S&P 500, while the most commonly traded S&P 500 EWI ETF is the Invesco S&P 500 Equal Weight ETF (RSP).
Below is a list of the top 10 holdings of SPY versus RSP:
Source: Yahoo Finance
The top 10 holdings of RSP make up 2.59% of the ETF’s total assets, while SPY’s top 10 holdings comprise 21.62% of total assets. In other words, the movements of SPY’s top 10 stocks have a much greater impact on the movement overall ETF than in the case with RSP’s top holdings.
Now, let’s look at how the different weighting schemes affect the sector weightings of the ETFs:
Source: Yahoo Finance
As you can see, the three sectors with the biggest weighting in the market capitalization-weighted SPY are technology (23.48%), financial services (15.69%) and health care (13.85). The three most heavily weighted sectors in the equal-weighted RSP are industrials (14.73%), financial services (14.31%) and consumer cyclical (14.07%).
The majority of sectors that comprise the S&P 500 fell on Monday. In fact, the only ones that gained were energy, real estate and utilities.
Source: Select Sector SPDRs
This was not surprising given that oil prices soared Monday after 5.7 million barrels were knocked out daily production due to the attacks in Saudi Arabia, boosting oil-related stocks, as well as relative safe havens like real estate and utility stocks.
The different weightings of the sectors obviously have an impact on the overall performance of the ETFs as well. For instance, in Monday’s trading, SPY fell 0.29%, while RSP gained 0.11%.
While SPY moved more than RSP in Monday’s trading, generally, RSP is more volatile than SPY. This is because the smaller the market cap of a stock, the more volatile it typically is. And while both ETFs are based on the S&P 500, RSP gives a greater weighting to smaller companies within that index.
Volatility is something option traders usually look to exploit, but there are a number of reasons I prefer trading SPY to RSP.
For starters, SPY is much more liquid than RSP. The average daily trading volume of RSP is less than 550,000 compared to more than 69.6 million for SPY. This liquidity helps traders move into and out of options quickly and reduces the chances of getting stuck in a trade when the market moves against you.
Next, SPY offers a much larger selection of options to choose from in terms of expiration dates and strike prices. In fact, RSP only trades monthly options, while SPY options have expiration dates on Mondays, Wednesdays and Fridays, and each day has dozens of strike prices to choose from.
This gives me a chance to cherry-pick what I consider to be the best opportunity in the marketplace on a daily basis for the Trade Of The Day.
Traders who followed Monday’s Trade Of The Day, for example, could have made up to 38% on a put option on a day SPY closed just 0.3% lower. And they could have achieved that outcome in just 30 minutes!
And that is the goal: To get into the trade and then exit a few minutes to a few hours later, walking away from the market for the day richer than you were when you woke up.
The final reason I prefer trading SPY to RSP is that trading the same security day in and day out gives me a huge edge. As I said, I am intimately familiar with SPY’s chart, key support and resistance levels and the technical patterns that work best for it.
This helps me to generate consistent profits, typically in the double-digit to triple-digit percentage range.
If you’re interested in trying your hand at trading SPY alongside me, you can start as early as tomorrow.