Premium Collection With Nasdaq-100 Weekly Index Options Credit Spreads

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Index Options

Generating consistent weekly premium collection using options on the Nasdaq-100 Index has a variety of challenges, including selection of an option strategy, expiration dates, strike prices and market factors. Utilizing the right set of tools, methodologies and education, and selecting a strategy that suits your risk profile and trading style can be achieved with this guide. The most popular investor strategy is selling Call and Put Vertical credit spreads.

Index options on the Nasdaq-100® Index, including full-value NDX and reduced-value NQX, are particularly well suited for this short-term strategy. These European-style, cash-settled index options remove the risk of assignment around expirations, leading to lower transaction costs versus equity options. Moreover, the underlying indices diversify away single stock risk and gaps from corporate actions, which is ideal for selling credit spreads.

NDX index options leverage the full value Nasdaq-100 Index while the NQX contact provides 1/5 the exposure to the same flagship index. These two contracts provide different notional contract sizing to fit the needs across retail and institutional customers.

Choosing expirations that suit your trading frequency and strike prices that fit your risk tolerance is crucial for consistent results. The more expirations and strike prices that are available, assuming a liquid market at the desired time of execution, the more likely it is that you will find a good match. Index options fit all these criteria with weekly options, a large number of strikes, deep liquidity and flexible contract sizes for both retail and institutional investors.

Strategy Overview

Selling credit spreads is a high probability neutral strategy, allowing investors to enter the trade with a loose directional view on the underlying. This is a very popular strategy with technical analysts using oscillators that identify overbought and oversold conditions such as MACD (Moving Average Convergence Divergence) and RSI (Relative Strength Index). It involves entering a Put Credit Spread with a neutral/slightly bullish view (oversold) and a Call Credit Spread with a neutral/slightly bearish view (overbought). Furthermore, Call and Put Credit Spreads can be strung together as an index reaches oversold and overbought conditions.

Expiration Dates

Weekly options that are 1-3 weeks from expiration are ideal for this strategy. When selling options, time decay (Theta) is working in your favor, and decays faster, as it gets closer to expiration.



Strike Prices

Investors have flexibility when choosing strike prices and there are generally two major inputs to consider – probability and risk/reward. Understanding the relationship between probability and risk/reward is critical to picking the right strategy for each investor's risk tolerance. The trade-off between risk/reward and probability is illustrated using the following examples of different strike prices.

Higher Probability with Worse Risk/Reward Strategy:

Sell a far out-of-the-money option:

 0.10 Delta

Buy a farther out-of-the-money option:

 0.02-0.05 Delta

This strategy will collect small amounts of premium upon each expiration with a very low chance of loss; however, when the index moves in the adverse direction, investors can experience losses many times greater than the income received. Employing this strategy will have a very high probability of profit (POP), greater than 90%, with a high risk to reward ratio. Typically risking between $1,000 and $2,000 for every $100 earned (10-20 to 1 Risk/Reward).



Lower Probability with Better Risk/Reward Strategy:

Sell a near-the-money option:

.40 Delta

Buy an out-of-the-money option:

.20 Delta

This strategy will collect larger amounts of premium on every expiration with a higher chance of loss; however, when the index moves in the adverse direction, investors will experience a much smaller loss compared to the income received.

It will have a relatively lower POP of 67% with a much better risk to reward ratio. Typically risking around $250 for every $100 earned in income (2.5 to 1 Risk/Reward).



Consistency is Key

Call and Put Vertical credit spreads on index options are simple option strategies with defined risk and reward profiles to potentially generate income using a methodical approach. Choosing the same expiration dates and deltas for your strike prices will lead to consistency with a reliable probability of success. Using index options on the Nasdaq-100 Index provides investors with flexibility in contract size and higher implied volatility for increased income over other broad-based index options.

The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs.  Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions.

Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Options , Investing Ideas , US Markets

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Tony Zhang

Tony Zhang


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