Options Investing: Introducing the Nations NDX PutWrite Index

Many people thought put options were un-American. So with the introduction of exchange-traded options in the 1970s there was only one type of option offered. Those options were “call” options which give the owner of the option the right, but not the obligation, to buy the underlying asset at the exercise price at or before the expiration date. The other type of option, “put” options, had been traded privately along with call options for years, but weren’t initially listed on exchanges. 

Put options give the owner of the option the right, but not the obligation, to sell the underlying asset at the exercise price at or before the expiration date.  If the market price of the underlying asset at the time of option expiration is below the exercise price of the option then it makes sense for the owner of the put option to exercise that option and “put” the asset to the option seller at the higher exercise price.  But when options were first being offered for trading on exchanges some thought it was dangerous to make it easy for investors to bet against a stock. The phrase they used for put options was un-American.

In hindsight that doesn’t make much sense. Put options are like insurance and buying insurance on your car or home isn’t un-American. In fact, car insurance is downright smart if you can’t afford to take a complete loss on your car. If you total your car you have the right to “put” it to the insurance company, making them buy the car from you for some previously agreed upon amount. 

So clearly put options aren’t really un-American. And as we know, selling insurance can be pretty profitable. Even after your insurance company settles claims and pays wages and overhead there is usually some profit left over. That’s because the price you pay for insurance is usually just a bit higher than the insurance is worth given the odds of a loss.  But you have to buy insurance so you’re willing to pay a little bit extra to shift the risk to someone else.

The same relationship ultimately exists between an exchange-traded option’s price and its value.  Over time, put options cost more than they’re worth. The difference compensates the option seller for the extra risk taken.

This raises the question; would it make sense to take some of the money one might invest in an index such as the Nasdaq-100 index and instead systematically sell (we sometimes refer to selling an option by saying we’ve “written” the option) put options on the index?  Since we have the money set aside, this would be a cash-secured put and it would likely offer some advantages over traditional index investing.  In this series we’ll examine such a strategy including the historical risk and returns along with examining why this sort of strategy might work over time, when it will be particularly attractive and when it will underperform simply investing in the index.

Introducing the Nations® NDX PutWrite Index

The Nations® NDX PutWrite Index measures the performance of a hypothetical portfolio that sells Nasdaq-100 Index (NDX) put options which are collateralized by cash reserves held in an interest-bearing account.  The Nations® NDX PutWrite Index is designed to sell a sequence of one-month, at-the-money Nasdaq-100 Index puts and invest the cash in one-month Treasury Bills. The number of NDX put options sold each month varies but is always limited such that the amount of cash on hand can finance the maximum possible loss from final settlement of the NDX put options even if the index dropped to zero.

The goal of the Nations® NDX PutWrite is to capture much of the upside appreciation in the Nasdaq-100 index while substantially reducing the volatility of returns and capturing the difference between the cost of an option (what we collect when we sell the option) and the ultimate value of the option.  The index was initiated on December 15, 1994 with an index value of 100.00.  From then to the end of 2018 it had an annualized return of 9.24% while the Nasdaq-100 Total Return Index has an annualized return of 12.83%.  But where a PutWrite index can really shine is in risk-adjusted return.  During that same period the Nations NDX PutWrite Index displayed just half as much risk as the Nasdaq-100 Total Return Index.

What about so far this year?  The closing value on Monday, October 7, 2019 was 937.85.  The index is up 11.09% for 2019.

The goal of this series is education.  We’ll start with the basic building blocks for those who want to learn more about Nasdaq-100 options and how they might use them to cut their risk in half while capturing most of the appreciation of the index.  We’ll discuss the basic concepts regarding options in general and Nasdaq-100 options in particular because Nasdaq-100 options can be a great way to invest in the most interesting, dynamic companies in America.

Let’s begin by learning more about Nasdaq-100 Index options.  During my next post Thursday I’ll continue to describe our PutWrite Index including detailed historical returns including the most up-to-date returns and risk for what has been an interesting year so far.

Options on the Nasdaq-100 Index

The put options sold in the Nations NDX PutWrite Index are options on the Nasdaq-100 Index.  The ticker symbol for the Nasdaq-100 Index is NDX.

NDX options expire at regular intervals.  The NDX options used in the Nations NDX PutWrite Index are those options which expire on the third Friday of each month.  Once those options expire new options expiring on the third Friday of the following month are sold. 

The strike price of the NDX options sold is the first strike price below the current market level of the Nasdaq-100 Index. 

The value of a single NDX put option contract is the level of the Nasdaq-100 Index multiplied by $100.  With the Nasdaq-100 Index at Monday’s closing level of 7725.13 each at-the-money put option has an underlying or notional value of $772,513 (7725.13 x $100). 

Nasdaq also offers options with a smaller value which would be appropriate for those who wanted to take advantage of the benefits of a PutWrite but have a lower risk threshold.

The Nasdaq-100 Reduced Value Index is equal to 1/5th the value of the regular NDX index and options on the Nasdaq-100 Reduced Value Index are perfect for a PutWrite with a lower risk threshold. These options trade under ticker symbol NQX.  An NQX put option with a strike price equal to at-the-money would have an underlying or notional value of just $154,502.60 ($772,513 / 5).

NDX and NQX, like most index options, can only be exercised at expiration making them particularly appropriate for a PutWrite index.  They’re also settled in cash, again like most index options, because settling the options by the exchange of off the stocks in the index, in the correct proportion, would be unwieldy.  Again, this makes them perfect for a PutWrite index.

Join Us Twice a Week as We Learn More about Options on the Nasdaq-100 and the Nations NDX PutWrite Index

We’ll have new posts each Monday and Thursday describing the Nations NDX PutWrite Index but more importantly we’ll learn about options and how NDX and NQX index options can help your investment returns.

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

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