The answer is, it depends. But I do have my preferences.

Liquidity

Both ETFs and Indexes are very liquid.  As I write this the At The Money Call in  SPX has an open interest of 45,000 contracts. The SPY At The Money Call has an open interest of 85,000 contracts. So both are very liquid. Major hedge funds though trade the indexes because they trade directly with the market makers.

Advantage: Even

Commissions

Commissions play a role because the SPX is ten times larger than the SPY. So if you want to trade $1,000 credit spread, you can do it with a 1 contract spread in SPX or a 10 contract spread in SPY. If you are paying per contract, the commission to trade SPY is ten times larger. if you are trading a flat fee per trade, regardless of the number of contracts, then it does not matter which one you choose.

Advantage: Indexes

Assignment

Indexes are European style options which means you cannot get assigned early. There is no early assignment with European options. ETFs are American style options and can be assigned anytime which can screw up your trade.

Advantage: Indexes

Bid/Ask Spreads

The Bid/Ask Spreads in ETFs are much smaller than in Indexes. Often times the spreads are only 1 penny. Keep in mind though that a 1 penny spread in an ETF is the same as a 10 cent spread in an Index. And if you have a 5 penny spread in an Index that is better than you can get in an ETF.

As a trader you should never be paying the Bid or the Ask. You should be paying somewhere in the middle. So if the spread is 23/24 you should be paying 23.50 or better.

A wide bid/ask spread can hurt you if the market is going crazy and you need to get out of a position immediately. It also takes a little more finessing to get a good price on a trade. Beginners should stick with ETFs for this reason.

Advantage: ETFs

Taxes

Indexes have preferential tax status. 60% of the income is counted as long term, and 40% is short term no matter how long you were in the trade. For ETFs, the tax implications are the same as stock. Since our option selling trades are concluded in about a month on average, the 60/40 tax structure can save us a lot of money.

Advantage: Indexes

Settlement

Most Indexes are settled on the market open on expiration Friday. ETFs settle at the close on expiration Friday. The Index settlement can cause confusion and crazy settlement prices. That is why it is best not to go into expiration. Take your trades off before and save the heartache.

Indexes are cash secured positions. ETFs are just like stock so if you go into expiration short an option you will be required to buy or sell shares of the ETF. An assignment can easily be remedied but it can cause margin calls and other problems.

Advantage: ETFs

Amount of Capital:

With ETFs you can trade spreads with as little as $100. With an Index like the SPX $500 is the minimum. I have heard several traders say that anyone with less than $5,000 should be trading the ETFs, and those with $5k or more should stick to Indexes.

For newer traders with less capital, stick with the ETFs. But I recommend traders start with $10,000. And if you are trading that much or more, the Indexes offer the better bet. As you get better as a trader and your account size grows you may open a portfolio margin account which is margined differently from a regular account. That will really allow you to trade more contracts and the Indexes will allow you to do so without upsetting the market prices with large orders.

Advantage: Indexes

Final Score: Indexes 4 points, ETFs 2 points.

My personal opinion: I stick with Indexes because of the commissions, the tax structure, and the ability to trade more money with a smaller number of contracts. I would rather trade 100 contracts than 1,000 and make $100 per spread than $10.

Smaller traders get eaten alive by the commissions when trading ETFs.  Once you learn how to enter a trade, the bid/ask spread becomes a non issue. Getting out of a position in a fast moving market can be more difficult but it varies from Index to Index. And if you don’t go into expiration with your trades, the settlement will not affect you either.

Trading Indexes vs. ETFs is a post from Option Selling.
To learn how you too can earn 8-12% Monthly Returns Safely and Conservatively check out OptionGenius.com

For October 2009, OptionGenius.com was  + 2.72%.

Not very impressive is it. But the S&P was down -1.98%.

Trade #4 for the month was rolled forward to November. If I had not rolled it, it would have expired worthless and with a profit. Instead it is now  November Trade #3.

Both iron condors did great in October. I took a more conservative stance this month because of October usually being a very bad month for the markets. And this one did not disappoint.

It started out smooth, then dropped towrdas the end of the month, then reversed and rallied up just as fast as it had dropped.

Can you saw “whipsaw?”

But  both condors did great with no adjustments required. What really hurt was an IWM butterfly that busted my chops. If I had just put that trade on and forgot about it, it would have been profitable, but alas, that’s not how it works, so this trade was a loser.

Regardless, it was a positive month in a year that has been anything but ordinary. The site is still on track for a 50% plus year if November and December work out.

Right now I am up + 36.11% for the year. Which is better than most hedge and mutual funds, and double the S&P.

Results for October 2009 is a post from Option Selling.
To learn how you too can earn 8-12% Monthly Returns Safely and Conservatively check out OptionGenius.com