A PutWrite Can Be Much Better When Things Are Bad

The Nations NDX PutWrite Index closed yesterday, October 23, 2019, at 960.75 which is a gain of 13.8 percent for the year.

The Nations NDX PutWrite Index is designed to generate returns which are similar to the underlying Nasdaq-100 Index but with less volatility.  The result, over time, has been substantially superior risk-adjusted returns. 

This superior risk-adjusted return is generated because while the PutWrite Index tends to trail the underlying index on an absolute return basis (both up and down) it reduces volatility by a much greater degree.  Users may regret reduced absolute return when the underlying Nasdaq-100 index zooms higher but they appreciate the reduced volatility over time and particularly when the underlying index drops precipitously. 

For example, in 2000, the Nasdaq-100 Total Return Index (which includes dividends) fell 36.8 percent as investors fled tech stocks.  But that decline meant that put options became much more expensive which helps the PutWrite Index as it sells new just out-of-the-money put options each month.  The Nations NDX PutWrite Index finished the calendar year 2000 with a loss of just 3.8 percent.  The PutWrite Index told a similar story in 2002 with the Nasdaq-100 Total Return Index lost 37.5 percent and the PutWrite index lost just 5.3 percent.  The PutWrite did it again in 2008 when the Nasdaq-100 Total Return Index lost 41.6 percent and the PutWrite lost just 34.1 percent.

How is it that a PutWrite strategy can do so much better when times are tough?  In part it’s because that’s when the options the PutWrite index is selling get so expensive.  For example, during the roll that occurred in July 2001, when the Nasdaq-100 Index was under considerable pressure but before 9/11, the put options sold for the PutWrite Index provided a downside buffer for the next 30 days of 6.5 percent and that’s almost exactly what the index lost when it fell 6.7 percent during that period.  The result was that the underlying index lost that 6.7 percent while the PutWrite Index lost just 0.1 percent. 

By adding new inputs to the ultimate performance of an index, and the price of the options sold and the way they erode are important inputs in a PutWrite Index, the impact of diversification is increased.  In fact, there is no year since the Nations NDX PutWrite Index was initiated in 1994 when the underlying Nasdaq-100 Index lost ground and the PutWrite did worse. 

One advantage of the Nations NDX PutWrite Index is that it uses NDX options.  NDX options trade on several exchanges so there is competition among market makers.  This competition generates tight markets (a tight market is one with a small difference between the bid and ask prices) and deep markets (a deep market is one with a large number of contracts bid for and offered for sale).  For those with a smaller portfolio who want to use an NDX PutWrite strategy Nasdaq exchanges offer Nasdaq-100 Reduced Value Index options, ticker symbol NQX.  NQX options are just one-fifth the size of NDX options so the notional value of an at-the-money put would be about $158,000.  There’s an option for every Nasdaq-100 PutWrite user.

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