Mini Index Options

What are Mini Index Options in Options Trading?

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Mini Index Options - Definition

Mini Index Options are index options with only one tenth the contract size of regular index options.

Mini Index Options - Introduction

First introduced to the options trading community in the form of Mini-NDX Index Options back in 2000, Mini Index Options are Index Options that cover only one tenth the size and therefore cost only one tenth the price of regular index options. The lower cost of Mini Index Options gives the small retail options trader a chance to get more involved in trading on the broader market. Mini Index Options are not to be confused with Mini Options even though they are both only one tenth the size of their regular counterparts.

(Read more about Mini Options and Index Options)

This tutorial shall explore in depth what Mini Index Options are, how they work, the kinds of Mini Index Options there are in the market, their differences between other ways to trade indexes using options and some possible options strategies.

Content

What Are Mini Index Options | Kinds of Mini Index Options | Differences Between Mini Index Options & Index Options | Differences Between Mini Index Options & ETF Options | Unique Options Strategy Using Mini Index Options | Advantages & Disadvantages of Mini Index Options

What Are Mini Index Options?

Mini Index Options are a scaled down version of Index Options just like how Mini Options are a scaled down version of regular stock options. An index is a aggregate number indicating the aggregate performance of the stocks that make up the index. Prior to the invention of Index Options and Index Futures, an index is just a number for scorekeeping purpose of the performance of the general market. With the invention of these derivative products, indexes such as the Nasdaq100 and the S&P500 ceased to be just numbers for reference but actual tradable assets just like a stock! Index Options and Index futures allow these indexes to be traded directly in order to speculate not on the performance of specific stocks but on the performance of the overall market or the specific basket of stocks covered by the indexes. However, index options can be quite expensive, denying small retail options traders access to trading the overall market using options and that led to the invention of Mini Index Options.

What Are Mini Index Options?

Mini Index Options are index options that are based on only one tenth the value of the underlying index. In order to achieve this effect, an index one tenth the size of the regular index was first created. In the case of Nasdaq100 (NDX), an index that is only one tenth its value called the Mini-NDX was created with the symbol MNX. In the case of S&P500 (SPX), an index one tenth its size called the Mini-SPX was created with the symbol XSP. Options created around these mini indexes were known as Mini Index Options. So, rather than them being Mini "Index Options" (mini version of regular index options), they are actually "Mini Index" Options (options based on "mini indexes").

Kinds of Mini Index Options

There are two main kinds of Mini Index Options available for trading in the options market right now:

Nasdaq100 Mini-NDX Index Options (MNX) and S&P500 Mini-SPX Index Options (XSP)

Nasdaq100 Mini-NDX Index Options (MNX)

Launched in 2000, the Mini-NDX Index Options are options offered on a one-tenth scaled down index of the NDX (Nasdaq100) known as the MNX. The MNX will always be automatically one-tenth the value of the NDX. The NDX closed at 2,877.94 on 21 June 2013 and the MNX closed at 287.79 which is 2,877.94 divided by 10 and rounded off to two decimal places. As the MNX is only one-tenth the value of the NDX, its options are also much much cheaper, although not exactly one tenth the price of the regular index options at the same strike price. Get the Contract Specifications of Mini-NDX Index Options.

S&P500 Mini-SPX Index Options (XSP)

Launched in 2005, the Mini-SPX Index Options are options offered on a one-tenth scaled down index of the SPX (S&P500) known as the XSP. Like the MNX, the XSP will always be one-tenth the value of the SPX. The SPX closed at 1,592.43 on 21 June 2013 while the XSP closed at 159.24, which is 1,592.43 divided by 10 and rounded off to two decimal places. Like the Mini-NDX Index Options, even though the XSP is exactly one tenth the size of the SPX, their options may not be exactly one tenth the price of the regular index options at the same strike price. Get the Contract Specifications of Mini-SPX Index Options.

Differences Between Mini Index Options and Index Options

Even though Mini Index Options are supposed to be a one-tenth scaled down version of regular index options, there are actually significant differences between the two kinds of index options. The two main differences are actually in the pricing as well as the strike prices available. Lets explore these differences to understand their impact in options trading as well as what gave rise to these differences.

Price Not Exactly One-Tenth

For a start, as mentioned above, even though the mini indexes are exactly one tenth the value of the regular index, Mini Index Options may not be exactly one tenth the value of the regular Index Options at the same strike price. The picture below compares the call options chain of SPX Call Options and XSP Call Options expiring on the same month.

Comparing Mini Index Options with regular Index Options

If you compare the comparable strike prices such as the SPX Index Options 1590 strike price with the XSP Mini Index Options 159.00 strike price, you will see that the XSP Mini Index Call Option at 159.00 strike price (asking at $3.25) is not one tenth the price of the SPX Index Call Option at 1590 strike price (asking at $30.90). If Mini Index Options are exactly one-tenth the value of regular Index Options, the XSP Mini Index Call Option at 159.00 stirke price should be asking at $3.09 or $3.10 instead of being ($3.25 - $3.10) $0.15 more expensive. Comparing another comparable strike price of 1580 against 158 revealed the same situation where the Mini Index Option is more expensive than being one-tenth the price of the regular index option. You will also notice that the bid prices of Mini Index Options are also generally lower than one tenth of regular index options. This lower bid price and higher ask price resulted in extremely large bid ask spread of Mini Index Options vs regular Index Options.

The reason for such disparity is that even though the mini indexes themselves are exactly one-tenth the value of the regular indexes, the options offered on the mini indexes will come under their own set of pricing dynamics due to market forces of supply and demand. In general, the lower the demand, the wider the bid ask spread that market makers offer in order to hedge against their risk of making market on the less liquid asset. This is done by increasing the extrinsic value on the ask price and lowering them on the bid. As you can see from the volume and open interest in the picture above, regular index options are still much much more popular and liquid with much higher open interest than Mini Index Options. This lack of interest and demand is probably the main reason behind the wide bid ask spread and consequently the higher than one-tenth asking price. (Read more about options liquidity)

The implication of such higher bid ask spread and extrinsic value is that if you intend to buy ten contracts of a Mini Index Option, you will actually be better off buying a single contract of the regular index option instead.

Example of 10 Contracts of Mini Index Options From the picture above, XSP Mini Index Call Option at 159.00 strike price is asking at $3.25 while SPX Index Call Option at 1590 strike price is asking at $30.90. 10 contracts of XSP Mini Index Call Options @ 159 = ($3.25 x 100) x 10 = $325 x 10 = $3,250 1 contract of SPX Index Call Options @ 1590 = $30.90 x 100 = $3,090 You will be spending $3,250 - $3,090 = $160 more in order to speculate on the exact same move as you would buying a single contract of SPX Index Call Options.

Lesser Strike Prices To Choose From

Regular Index Options usually have twice as many strike prices as Mini Index Options have due to the fact that Mini Index Options do not offer strike prices between the dollar. Lesser strike prices translate into lesser flexibility and lesser choice and a lower ability to get as close to at the money option as the regular index options can. For instance, if the S&P500 is at 1585 with the XSP at 158.50, you will be able to buy exactly at the money options by taking the 1585 strike price options of the SPX Index Options while you would be split between the near the money 158 or 159 strike price for the Mini Index Options.

Differences Between Mini Index Options and Index Based ETF Options

Another options trading product comparable with Mini Index Options are Index based ETF options such as the QQQ options and the SPY options. The QQQ is an Exchange Traded Fund (ETF) based on the Nasdaq100 while the SPY is an ETF based on the S&P500. Both ETFs are designed to track the underlying index as closely as possible in order to offer an easy way of buying into both indexes directly without having to trade using options and futures. Both ETFs also offer options just like Index options and Mini Index Options which makes trading options on these ETFs comparable to trading Index Options and Mini Index Options on these same indexes.

However, there are several major differences between trading Mini Index Options and the ETF options, mainly in terms of tracking of the underlying index, pricing and liquidity.

In terms of tracking of the underlying index, apart from trading Index Options directly, nothing beats Mini Index Options as the mini indexes derive their value directly from the underlying index itself. ETFs on the other hand has significant tracking errors even though they endeavor to move in the exact same magnitude as the indexes they are tracking. This means that while the underlying value of Mini Index Options will move exactly the same way as their underlying index, the ETFs may not. This tracking difference may be so huge on a single day that you might profit from trading Mini Index Options while making a loss on the ETF options of the same underlying index! For instance, the NDX closed down by 0.43% on 21 June 2013 while the QQQ (which tracks the same Nasdaq100) closed down by 0.52%. The SPX closed up by 0.27% on the same day while the SPY (which tracks the same S&P500) closed down by 0.21%, which is exactly the opposite direction. This tracking error by the ETF options is the main advantage Mini Index Options have over ETF options. Mini Indexes which the Mini Index Options are based on will always move exactly the same way their underlying indexes move.

In terms of pricing and liquidity, ETF options have the significant advantage of being both much much cheaper than Mini Index Options with much better liquidity. In fact, QQQ options are amongst the most liquid derivative products in the world. Furthermore, Near The Money QQQ call options today are asking only at $1.60 while the same near the money MNX call options are asking at $6.20. This is why to date ETF options continue to be much more popular than Mini Index Options.

Unique Options Strategy with Mini Index Options

Options traders can perform with Mini Index Options every kind of options strategies that involves only options since its underlying asset cannot be purchased. However, Mini Index Options make possible a unique options strategy and that is ratio spread against a single Index Option! A Ratio Spread is a partially hedged position that buys and writes options of different strike price and/or expiration month on the same underlying but in different amounts. A regular debit spread or credit spread would buy and write the same number of options contracts on the long and short leg but not a ratio spread. One could actually perform partial hedging by writing Mini Index Options even against a single Index Option contract. However, one should take note that the short Mini Index Options would be treated as naked writes (requiring margin) as options brokers will not normally recognize the short Mini Index Options as part of an options spread against the Index Option.

Advantages of Trading Mini Index Options

:: Cheaper alternative to Index Options

:: Mini Indexes track their underlying Indexes perfectly

:: Can be used for partially hedging against Index Options

Disadvantages of Trading Mini Index Options

:: Wide bid ask spread and high extrinsic value due to lower liquidity

:: Much more expensive than ETF options

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