Volatility traders look to NDX versus SPX
09/07/17

Volatility is a term that gets used a lot. But what is volatility? How is it measured? Where can it be found?

In the simplest terms, volatility indicates how much uncertainty (or risk) there is in the amount of movement in a stock’s price—the more movement there is, the higher the volatility. Mathematically, volatility can be calculated after the fact by measuring the fluctuation in a stock’s price over time. When measuring actual volatility, it is referred to as “historical volatility” because it is something that occurred in the past. 

To get an idea of what the markets think about future volatility, traders can calculate “implied volatility”. This measurement can be calculated in the prices of the options for a stock, and is one way traders try to manage the amount of risk in their portfolio. 

The options term for measuring implied volatility is vega, which is the expected change in the value of an option’s price for a 1% move in the volatility of the stock’s price. When there is greater uncertainty in the potential movement in a stock’s price, the markets will price that potential risk into options prices. This will cause vega to rise, as well as the prices of the options.

Two indexes that many traders seek out in search of volatility are the S&P 500 Index (SPX) and the Nasdaq 100 Index (NDX), a market capitalization–weighted index of the 100 largest non-financial companies. For traders looking for potential opportunities among higher volatilities, currently the NDX provides more of an opportunity than the SPX.

Below is the 6-month chart of the 30-day implied volatility of the NDX:

Nasdaq 100 Index (NDX), 3/17-9/17

Source: OptionsHouse by E*TRADE

Compare that to the 6-month chart of the 30-day implied volatility of the SPX:
S&P 500 Index (SPX), 3/17-9/17

Source: OptionsHouse by E*TRADE

The implied volatility in the NDX is consistently higher than the implied volatility in the SPX. In fact, most recently, the implied volatility for the NDX was around 16, while that for the SPX was around 12. Perhaps the reason NDX has greater trading opportunities due to higher volatility is that the popular FAANG stocks, including Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Netflix (NASDAQ: NFLX), and Google (NASDAQ: GOOG), as well as some of the other larger technology stocks, have a greater weighting and effect on the NDX than the SPX. 

 

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