Index Options Trading: Why you Should Explore this Popular Investment

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If the pandemic taught the world anything about money, it was this: Growing your wealth, whether that be through savings or investing, is crucial. So, when jobs started reopening and people were able to bring in wages, some added market investing to build a safety net. Although putting your cash in the stock market can be a risky venture, responsible diversification can bring profitable returns and help grow your bottom line.

To begin investing, you could add individual stocks to your portfolio, or you could choose mutual funds, which already include a diversified selection of professionally managed stocks. But given the market volatility during 2020 and 2021, you might also consider adding options to your portfolio.

What is an Option?

An option is a contract you purchase, allowing you to buy a particular stock or index (a group of stocks) by a specific date at a chosen strike price. If you don’t use the option by the expiration date, you lose the money you paid for the right to exercise that option.

For instance, say you think AMC Entertainment Holdings (NYSE:AMC) will rise to $60 per share over the next 2 months. You might buy a call option giving you the right to purchase it at that strike price before the 2-month deadline. If AMC rises above $60 before the expiration date, you could exercise your option, immediately sell the stock and realize a gain. On the other hand, if the stock never reaches the $60 strike price and you don’t buy the stock, you lose the premium you paid for the option.

Index Options

To understand index options, you first have to know: What is an index? An index is a group of stocks used as a benchmark for a market sector as a whole. For example, the Nasdaq-100 Index (NASDAQ:NDX) includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization. So, that index helps you track the performance of the biggest companies on the exchange, which could give you a peek into the market at large. 

The problem you can run into with an index like the NDX is that its current trade price is nearly $14,000. You can’t buy a share of an index, and to buy the basket is not realistic for most investors.

An Option for the Novice Investor 

Nasdaq recognized this barrier due to historical growth and index performance, and wanted to allow all investors to reach the companies included in the Nasdaq 100 Index, so they launched a smaller index at a lower price point. The Nasdaq-100 Micro Index (NASDAQ:XND) has a value of around $140 per share or 1% of the larger index. 

Given the lower price, smaller investors have the opportunity to use options for a potential profit and exposure to the companies represented on the larger exchange.

Adding Diversity and Reducing Risk

As with any investment, be sure to do your research and only invest when you fully understand the tool you’re using and the losses you could incur. Because options don’t require you to buy, dabbling in the new XND index with call options might be the perfect way to introduce the vehicle into your portfolio.