The Nations NDX PutWrite Index and Correlation to the Nasdaq-100 Index

The Nations NDX PutWrite Index closed at 969.79 on Wednesday, October 30, up 14.88 percent for the year to date.

The options used in the Nations NDX PutWrite Index are NDX options (You can learn more about NDX options here: https://www.nasdaqtrader.com/content/phlx/NDXProductSheet.pdf).  NDX options are options on the Nasdaq-100 index itself.  NDX options are cash-settled meaning that at option expiration settlement is made by the payment or receipt of cash rather than exchange of actual shares of stock since that exchange would be unwieldy.  NDX options, and the smaller NQX options, are great tools for hedger and investors.

Any PutWrite index is going to be less volatile than the underlying asset it tracks because the movement of the put option is muted in comparison to the underlying asset.  For example, the Nasdaq-100 Index closed at 8083.11 on Wednesday.  If the index were to rally 1 point to 8084.11 an owner of the index would have made 1 point.  But an at-the-money option wouldn’t move in price by the same 1 point because there’s still substantial doubt about the option being in-the-money at expiration; the option would move by something less than 1 point.  That’s why the Nations NDX PutWrite Index has an historical beta of 51 meaning the magnitude of its movements is about 51 percent those of the underlying NDX Index.

So a PutWrite moves less than the underlying asset.  Another important question is, do the two move in the same direction?  They do move in the same direction which is what makes a PutWrite a good, lower risk, proxy for the underlying asset.  From the beginning of 1994 through the end of September 2019 the correlation of the Nasdaq-100 Index and the Nations NDX PutWrite is 83 percent.  Why isn’t the correlation 100 percent?  Because of the diversification injected by issues like the erosion of the put options over time.  That erosion not only reduces the correlation slightly, it also adds risk-adjusted return to the PutWrite Index.

The put option that has been shorted in a PutWrite moves somewhat less than the underlying index.  In the option world this sensitivity to the movement of the underlying index is called delta.  There is a huge range of NDX strike prices in each expiration and each strike price has a slightly different delta (movement relative to the underlying NDX Index) meaning there is an NDX option for every market thesis.  Issues like the time decay of option prices also inform any option strategy but delta is going to be the critical consideration for many strategies.

The Nations NDX PutWrite Index sells put options which are just below at-the-money at initiation meaning the strike price of the option is just below the current level of the Nasdaq-100 index when the options are sold.  Thus, these options initially move about 50 percent as much as the Nasdaq-100 Index.  That relationship will change as the Nasdaq-100 Index moves and as time passes but these options are the ones sold because they have the most time value.

The important consideration is that there is a range of strike prices available for those investors interested in executing their own Nasdaq-100 PutWrite strategy and each will have a unique correlation to the underlying Nasdaq-100 Index. 

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

Scott Nations

President of Nations Indexes: Scott Nations is the President of Nations Indexes and a bestselling author. Scott is also a Contributor to CNBC and regularly appears on-air to discuss markets, current economic events, and the outlook for a variety of financial vehicles. Nations Indexes is the world’s leading independent developer of volatility and option enhanced indexes and investment vehicles. The Nations Strategy Indexes, including the Nations NDX PutWrite Index, combine index investing and systematic option strategies to generate superior absolute and/or risk-adjusted return over full market cycles. The Nations Better Beta® Indexes are the first indexes which magnify gains without magnifying losses.
Scott is also the developer of the Nations suite of volatility indexes including VolDex® (ticker symbol VOLI) and TailDex® (ticker symbol TDEX), the first measure of the market’s expectations for a “tail event” or steep drop in prices.
Scott is the author of A History of the United States in Five Crashes, a general interest history of the five modern stock market crashes (1907, 1929,1987, 2008 and the Flash of 2010) which was published by HarperCollins in June 2017. Scott is the author of Options Math for Traders, published by Wiley & Sons in 2012 which was an Amazon.com bestseller. He is also the author of The Complete Book of Option Spreads and Combinations, published by Wiley & Sons in October 2014. Prior to founding Nations Indexes, Scott was a member of the Chicago Mercantile Exchange and was a market maker and floor manager for a leading index option trading firm. While there, he was responsible for development and implementation of proprietary option pricing models.

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