An additional advantage of trading SPX and futures options is the tax benefit. They qualify for special treatment under the Internal Revenue Code, where gains or losses from these contracts can be classified as 60% long-term capital gains and 40% short-term capital gains regardless of the holding period.
Many find that SPX options offer a tax advantage because of the way the IRS treats SPY options and SPX options differ from one another. During a long-term tax rate, investors are usually allowed 60% of the profits from trade when using SPX options.
Index funds—whether mutual funds or ETFs (exchange-traded funds)—are naturally tax-efficient for a couple of reasons: Because index funds simply replicate the holdings of an index, they don't trade in and out of securities as often as an active fund would.
Because index options are 1256 contracts,* they qualify for the 60/40 tax treatment—meaning 60% of your profits are treated as long-term capital gains and 40% as short-term capital gains. It doesn't matter how long you hold the position.
The wash sale rule only applies to stocks, bonds, options, ETFs, and mutual funds, or options and futures contracts on those types of investments.
What's more, by trading in and out of securities less frequently than actively managed funds do, index funds generate less taxable income that must be passed along to their shareholders.
Dividend income makes up an average of about 2% of the S&P 500's annual growth, with many companies paying 1 to 2% and some paying over 4%. So, if you hold a stock and never cash it out, there is a good chance that you are still paying taxes on dividend income.
While index funds do have benefits, they also have drawbacks to understand before investing. An index fund tends to include both high- and low-performing stocks and bonds in the index it's tracking. Any returns you earn would be an average of them all.
Fully Fund Tax-Advantaged Accounts
Maxing out tax-advantaged accounts can help to reduce your taxable income for the year. The less taxable income you have to report, the easier it might be to move down a tax bracket or two. Some of the accounts you may consider maxing out include: 401(k) or a similar workplace plan.
Investing in the S&P 500 can quickly grant you exposure to a diversified group of stocks, as this particular index represents roughly 80% of the U.S. stock market.
SPY (SPDR S&P 500 ETF Trust) on the other hand, is an ETF (exchange-traded fund) that also tracks the S&P 500 but can be traded like a stock and also has tradeable options. SPY equates to approximately 1/10th the value of SPX.
SPY is more expensive with a Total Expense Ratio (TER) of 0.0945%, versus 0.03% for VOO. SPY is up 28.31% year-to-date (YTD) with +$7.13B in YTD flows. VOO performs better with 28.36% YTD performance, and +$103.99B in YTD flows.
The Benefits of Trading SPX or Individual Stocks
Here are some of the benefits of trading SPX: They have a broad market index, so it gives you exposure to large cap stocks across all sectors.
Holding an investment for more than a year usually allows traders to take advantage of lower long-term capital gains tax rates. Capital gains distributions and dividend distributions require investors to pay taxes in the year these distributions are paid out.
So even if you held the option for a month, 60% of your gain will be considered long-term and taxed at the 20% preferential long-term capital-gains rate. The remaining 40% will be taxed at your ordinary income tax rate.
In the third quarter, a few billionaires bought shares of the Invesco QQQ Trust, an index fund that tracks the growth-focused Nasdaq-100. The Invesco QQQ Trust is heavily weighted toward the "Magnificent Seven" stocks, a group well positioned to benefit from emerging technologies.
Perhaps the most important reason to not exclusively rely on the S&P 500 is that it may not align perfectly with your personal financial goals. Every investor has a different risk tolerance, time horizon, and set of financial objectives.
If you traded any broad-based index options that are cash-settled, such as SPX, NDX, VIX, any outright futures contract, or option on futures, any gains/losses are subject to different tax treatment–60% long-term and 40% short-term.
Investing in an S&P 500 fund can instantly diversify your portfolio and is generally considered less risky than purchasing individual stocks directly. Because S&P 500 index funds or ETFs track the performance of the S&P 500, when that index does well, your investment will, too. (The opposite is also true, of course.)
The Bottom Line. Both index mutual funds and ETFs can provide investors with broad, diversified exposure to the stock market, making them good long-term investments suitable for most investors. ETFs may be more accessible and easier to trade for retail investors because they trade like shares of stock on exchanges.