07:52 AM, 24 Feb 2017 (AUS EST)   The market is currently closed       

Trading the ASX 200 Index: ETFs, CFDs, Futures and Options

The S&P/ASX 200 index represents the top 200 companies in Australia according to market capitalisation and liquidity. But how do you go about buying or shorting a large basket of 200 stocks in an efficient manner? Do you need to buy shares in every company or is there an easier way?

The three main ways to invest in the ASX 200 index that we will be discussing are CFDs, options and futures, and ETFs.

ASX 200 Exchange-Traded Funds (ETFs)

Exchange-Traded Funds can be used to replicate or mirror an index. How is this achieved? Shares are directly purchased from an exchange. Care needs to be taken so that the basket of purchased shares have the same weighting as the index. After this is achieved creation units are formed. These are typically bought up by large banks and institutions and further divided up into an equivalent amount of exchange-traded funds. It is important to note that these are created and based on a large basket of underlying shares. These exchange-traded funds can now be bought and sold with each ETF unit representing a small portion of the underlying index. The ETF cannot, however, be redeemed for physical shares despite being backed by them.

Three commonly traded ETFs that are loosely based on the ASX 200/300 are:

  • iShares MSCI Australia 200 ETF (IOZ)
  • SPDR S&P/ASX 200 Fund (STW)
  • Vanguard Australian Shares Index ETF (VAS)

ASX 200 Contracts For Difference (CFDs)

The S&P/ASX 200 CFD allows you to trade the ASX 200 index with a high amount of leverage. What are the benefits and risks of trading the ASX 200 with CFDs?

Contracts For Difference allow a speculator to bet on future price fluctuations for high profit. Instead of having to buy the underlying asset, margin is used to ensure there is enough capital to cover any potential losses. This means that you can bet a small amount of money and, if correct, make a large amount of gain. This goes for losses as well.

As an example, the current initial margin rate is $348 per CFD. The CFD index value is at 4100. The speculator wants 10 CFDs which have an initial margin of $3,480. The trader also needs to pay contract interest, open interest, and variation margin going forward.

  • If the index rises to 4200, the trader makes 100 points x 10 CFDs or $1,000.
  • If the index drops 50 points the trader loses $500 or 50 points x 10 CFDs.

Of course, you would need to add in all other fees to determine net profit. This allows the trader to play the price without the high capital cost of owning funds or shares. In the above example the trader tripled his investment with a moderate price move in the index.

ASX 200 Index Options (XJO)

Options are another way to trade the ASX 200.

S&P/ASX 200 Index Options are commonly referred to as XJO Index Options. Buying index options is a quick way to have broad market exposure with a small amount of capital. Although you have decent leverage, you cannot lose more than you initially put forward with options – which is not true of CFDs or futures. With XJO Index Options you pay an upfront premium. Each point of the index is worth $10. Keep in mind that these are Eurpoean style options which means they can only be exercised on expiry date.

An example of this type of transaction would be if the ASX 200 was trading at 4,100. You want an options contract that will expire in a couple weeks. Call options with an exercise price of 4,100 trade at $100. To break-even on expiry date, the index will need to be at 4,110 or higher. Any amount above this is profit, and even more so if you sell the option contract early. Any amount below this would be a loss of your $100, but nothing more.

ASX 200 Futures and Options

Futures and futures options are other derivatives you can use to trade the S&P/ASX 200 index. They are called ASX SPI Index Futures.

Futures contracts have quarterly expiry dates. With futures you are speculating on the future value of an index on a specified date. This is known as the ASX SPI 200 Futures. Each point is worth $10 if trading minis – which are smaller versions of a standard futures contract. If you trade the Mini 200 Futures, margin can be around $2,500. Thus, if the ASX 200 trades at 4,100, and a total value of $41,000 based on $10 per point, you can trade on margin with only $2,500 – which is 6% of the underlying value. Of course, your gains and losses are leveraged in this instance.

In addition to trading options on the Index, you can trade options on the futures contract. These are called ASX SPI 200 Index Options. The big difference between these and the index options is that they can be exercised at any time (not just on expiry date) and as such they are termed American options. As well, instead of paying a lump sum margin up-front, it uses a different method to calculate called SPAN (Standard Portfolio Analysis of Risk). This method attempts to match margin requirements to the maximum amount of one-day risk in options trading. Each tick is worth $25.

Getting Dividends

Dividend payments are a big part of Australian share trading. How are they paid out through the various insturments?

  • Since an index is just a listing of companies, you cannot buy one share of the ASX 200. The ASX 200 does not include dividends paid out, although the index price does fluctuate when dividend equity is removed from a company. To see the difference that is made by dividend accumulation, look to the S&P/ASX 200 Total Return Index or the Accumulation Index.
  • You will get dividends distributions when holding an exchange-traded ETF.
  • If you are trading CFDs, you will get an equivalent to the dividends in the form of cash flows paid out on the ex-dividend date. The CFD holder is entitled to the dividends and not the underlying share holder.
  • How do dividends factor into options? Options have dividends factored into the price. Call options appear cheaper than normal and put options appear more expensive than normal before ex-dividend date. They will automatically adjust for the removal of the dividend on that date. The reason for this is that the person holding the underlying shares is entitled to the dividends, not the options holder.
  • Holders of futures contracts do not receive dividends.

Trading an Index

If you are interested in trading the ASX 200 index, remember that you will need to do so with funds, futures, CFDs, or options since an index is a large basket of stocks designed to track broad performance as a benchmark – buying the index is simply not possible as it is a concept and not a tangible product.