Beginners Guide to Trading Index Options

What are Index Options?

Index options are derivative contracts traded on stock indices such as the Nasdaq-100® Index (NDX), Reduced Value Nasdaq-100 Index (NQX) and the Nasdaq-100 Micro Index (XND). Index options provide investors broad-based exposure to specific sectors and indexes with the benefits of diversification while removing single-stock risk.

Index options are used for a variety of strategies, and provide flexibility with a large selection of expirations and strikes. They are suitable for both retail and institutional investors to hedge portfolio risk, generate options premium and speculate.

NDX index options leverage the full value of the Nasdaq-100 Index while NQX contracts provide 1/5 the notional exposure to the same flagship index. For retail investors who wish to start trading index options with an even smaller notional exposure, they now have access to the XND contract, which is based on 1/100th the full value of the Nasdaq-100 Index.

ETF (QQQ) vs. Index Options (NDX)

Many investors find index options such as NDX simpler to manage compared to stock or ETF options such as QQQ. Index options are European-style (can only be exercised on expiration) and cash-settled as there are no deliverables for the underlying.

This lowers transaction costs by removing the requirement to close out positions at expiration to avoid assignment. NDX index options also offer both AM monthly expirations (which can be traded until 4:15PM EST on Thursday before expiration) and NDXP – PM Settled weekly expirations (which trade until 4:00PM EST on expiration day).

Additionally, under section 1256 of the Tax Code, firms trading certain exchange-traded broad-based index options, such as Nasdaq-100 Index Options (NDX, NQX and XND), may receive favorable tax treatment.

For traders, two major differences (between QQQ and NDX) that beginners should be aware of are dividends and contract size.

ETFs such as QQQ pay dividends and are American-style, which adds additional risk of early exercise on a dividend capture. Indexes do not pay dividends and are European-style, removing this risk.

Moreover, ETFs typically trade at a fraction of their corresponding index value, creating smaller notional value contract sizes compared to index options. NDX and NQX index option contracts are typically much larger vs. QQQ options contracts.

Credit Spreads on Index Options

The combination of high index values and large notational contract size are ideal for credit spread traders. Seeking high probability credit vertical spreads with enough option premium to overcome transaction costs requires a large number of strikes on broad based indexes, easily found on NDX, NQX and XND index options.

Additionally, with cash settlement credit spread traders find managing expirations extremely straightforward.

Popular Trading Strategies w/ Index Options

Speculation

Bet on a significant increase or decline of the Nasdaq-100 Index in the future

Bullish Strategy – Buying Call Options and Bull Call Spreads is a strategy investors use looking to profit from an expected significant rise in the level of the Nasdaq-100 Index (NDX, NQX and XND) over the term of the options contract or to hedge a short market position with limited risk.

Bearish Strategy – Buying Put Options and Bear Put Spreads is a strategy investors use looking to profit from an expected significant decline in the level of the Nasdaq-100 Index (NDX, NQX and XND) over the term of the options contract or to hedge a long market position with limited risk.

Income

Collect option premium based on a mild directional view of the Nasdaq-100 Index in the future

Bullish Strategy – Selling Bull Put Spreads is a strategy investors use looking to profit from an expected mild rise in the level of the Nasdaq-100 Index (NDX, NQX and XND) over the term of the options contract with limited risk.

Bearish Strategy – Selling Bear Call Spreads is a strategy investors use looking to profit from an expected mild decline in the level of the Nasdaq-100 Index (NDX, NQX and XND) over the term of the options contract with limited risk.

Hedging

Protect a portfolio against a market correction while remaining invested

Catastrophic Protection (Cheaper insurance) – Buying out-of-the-money (OTM) Put Options (30 Delta) is a strategy investors use to protect a portfolio from a major market decline in the level of the Nasdaq-100 Index (NDX, NQX and XND).

Comprehensive Protection (Expensive insurance) – Buying in-the-money (ITM) Put Options (60 Delta) is a strategy investors use looking to profit from a moderate market decline in the level of the Nasdaq-100 Index (NDX, NQX and XND).

Summary

Index options provide exposure for both retail and institutional investors to broad-based indexes such as the Nasdaq-100 Index for speculation, income and hedging purposes. Cash-settled index options provide efficiencies to transaction costs and profits with favorable tax treatment.

Moreover, European-style options transform busy and intensive expiration Fridays to relative ease by removing assignment risk. Combined with the contract size, investors selling short-dated options for income can find enough premium and stability in index options such as the Nasdaq-100 (NDX) index options traditionally not available on ETFs.

MORE EDUCATION

Introduction to Options

Basic options terminology and how one can get started on options with a small capital account.

Grow a Small Options Account Consistently and Confidently

Trading index options is now made extremely affordable. Learn how you can start trading index options with a small account size through the usage of Credit Spreads.

Introduction to Options

Basic options terminology and how one can get started on options with a small capital account.

Beginners Guide to Trading Index Options

Index options provide investors broad based exposure to specific sectors and indices with the benefits of diversification while removing single stock risk.

Grow a Small Options Account Consistently and Confidently

Trading index options is now made extremely affordable. Learn how you can start trading index options with a small account size through the usage of Credit Spreads.

Maximize Your Index Exposure with Index Options

Explore how Iindex options can provide investors with access to deep liquidity and unique advantages.

Top 3 Strategies for Index Options

Here are the top 3 index options trading strategies that a beginner option trader with a small account size can execute.

Traders Taking Full Advantage of Multiple Option Expirations

There are strategies that are very attractive based on an option expiring in the next day or two and now those opportunities are available multiple times a week.

How to Trade Index Options

Which are the popular index option strategies that a beginner option trader can execute? In this hour-long video, we do a detailed step-by-step tutorial on trading the Nasdaq vs. S&P 500 index.

Disclaimer: Nasdaq may, from time to time, exercise reasonable discretion as it deems appropriate in order to ensure Index integrity including but not limited to quantitative inclusion criteria. Nasdaq may also, due to special circumstances, if deemed essential, apply discretionary adjustments to ensure and maintain the high quality of the index construction and calculation. Nasdaq does not guarantee that any Index accurately reflects future market performance. Neither Nasdaq, Inc. nor any of its affiliates (collectively “Nasdaq”) makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Investors should undertake their own due diligence and carefully evaluate companies before investing. The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

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