Excitement over index options has soared among investors, individuals and institutions alike. These financial instruments offer a way for investors to align their portfolios with broader economic trends, while giving them more control over their investments.
The Nasdaq-100 Index (NDX), one of the leading stock market indexes, has become an important benchmark for investors seeking to add more depth to their portfolios.
“Index options allow investors to engage in a nuanced way, while mitigating risk,” said Kevin Davitt, Nasdaq’s Head of Index Options Content.
A Surge of Interest
Over the last three years, the trading of index options in capital markets has grown dramatically.
Between 2022 and 2023, the average daily volume of non-equity option trading rose by 7.5%, followed by 6.8% growth from 2023 to 2024 (year to date). Notably, S&P 500 index-pegged options saw a 31% increase from 2022 to 2023 and 8% from 2023 to 2024, and Nasdaq-100 Index Options (NDX) experienced a 59% rise between 2022 and 2023 and a 40% increase from 2023 to 2024.
“Index options have become the default tool for both retail and institutional investors to express market views,” said Davitt.
But what are they, exactly?
Index options are contracts that give investors the right to buy (call) or sell (put) the value of an index at a specified current (strike) price on a future expiration date. The options themselves are purchased with a premium payment. Investors can benefit if, for a call option, the index value at expiration is greater than the strike price, or if, for a put option, the index value at expiration is less than the strike price.
“Index options allow investors to more exactly define their investment journey, which contrasts with the linear exposure of owning stocks or ETFs,” Davitt said.
Options strategies enable investors to capture upside. At the same time, index options can also limit downside, because indexes are inherently diversified.
What’s Driving the Trend?
The movement toward index options is driven by several factors.
“The rise of interest rates higher in late 2021 and early 2022, along with significant pullback among the Nasdaq-100, impelled investors to rethink their strategies,” Davitt explained. “That meant more interest in index options, as opposed to individual equities options.”
This macro shift is combined with the increased awareness among investors that risk is reduced when following the pace of the overall market. This understanding has fueled the demand for more flexible investment tools like index options.
Davitt also noted that index options’ introduction of more frequent expiration dates during the week has provided investors with greater flexibility to buy contracts with more specific timeframes.
Not Just Institutions Anymore
The popularity of index options has been evident among both retail and institutional investors. This is significant for a space that was previously dominated by institutions.
Retail investors saw a 62% growth in average daily volume from 2022 to 2023, and a 38% increase from 2023 to 2024 (year to date). For institutional investors, growth was 57% between 2022 and 2023, and 41% from 2023 to 2024.
To Davitt, the rise of defined outcome ETFs, which have embedded optionality, has played a significant role in making index options more attractive to retail investors. These ETFs offer exposure to indexes with protection against downside risk and the possibility of significant upside. This makes them more accessible to retail investors, who can engage with these investments through a familiar ETF wrapper and avoid more complex arrangements.
Davitt added that yield-enhancing strategies, such as selling out-of-the-money calls, have become popular, particularly among baby boomers looking to de-risk their portfolios.
On the institutional side, index options have been a staple for decades, but recent growth could be attributed to increased interest and energy in a practice known as dispersion trading.
Davitt explained this complex and capital-intensive strategy, which is more suited to institutions.
“There are countless ways to affect a dispersion trade, but in nearly every case the manager owns options volatility in the top names in the index and short sells on overall index volatility. The expression benefits from low correlation between the constituents.” he said.
Regardless of these differences, investors across the spectrum are increasingly drawn to index options.
“Overall, we’re seeing that investors, both retail and institutional, are interested in flexible strategies to align their trading with their preferences,” Davitt said.