ITAP Company Spotlight


Nearly 17 years ago, Chuck Prince, then CEO of Citigroup, made a fateful proclamation to a Financial Times reporter in Japan. Like so many infamous quotes, it’s frequently taken out of context.

Against the backdrop of rising interest rates, Prince was asked about the recent cracks in the United States subprime mortgage markets. Citigroup was a significant lender, so his perspective was valuable.

The line that sticks with people to this day is: “As long as the music is playing, you’ve got to get up and dance.”

It’s easy to cast aspersion with the benefit of hindsight. However, if you read the statements that surrounded the soundbite, the message was less “Pollyanna.” Prince stated, “When the music stops, in terms of liquidity, things will get complicated.” Later, he said: “At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don’t think we’re at that point.”

The Citigroup CEO was right…and wrong. He was spot on that things would get complicated when liquidity receded. His timing was questionable. The subprime market was precariously close to the breaking point and just over a year later, Lehman Brothers would file for bankruptcy. That’s when things got particularly “complicated.”

Prince resigned from Citigroup four months after the interview in Japan. There are some real lessons to be learned.

Foremost amongst them – timing the market is next to impossible.

Prince was a seasoned financial veteran with a deep understanding of interconnected markets. There are countless examples of well-informed investors getting caught flat-footed when markets reverse. During both bull and bear markets, equity indexes tend to move to extremes. A Harvard Business Review piece centered on “The Overvaluation Trap” that decision-makers at publicly traded firms often fall prey to.

In short, the desire to “dance while the music’s playing” is driven by a multitude of factors.

Nasdaq-100® Outperformance

The Nasdaq-100® Index (NDX) has been on a bull market tear since late 2022. The other major U.S. benchmarks have also rallied, but as has been the case for (much of) the past two decades, the NDX is outperforming. Many individual and institutional portfolios more closely resemble the NDX because assets have piled into the best-performing sectors and securities. Those investors have largely been rewarded over the past 18 months. The NDX made another new all-time high in mid-June and has added ~72% since October 26, 2022. Over the same period, the S&P 500® Index has gained ~42%, and the small-cap Russell 2000 is higher by (only) 13%.

Source: YCharts

Dancing… with Downside

It’s easy to look at a chart and perhaps second-guess exposure coming into 2023 prior to a 35% drawdown in the NDX. It’s also commonplace to reduce equity exposure at the most inopportune times, like in October 2022. We have the benefit of hindsight and backdating some narrative to rationalize our decisions. Here’s the thing: it’s easier to continue “dancing while the music is playing” with an understanding of index options.

The past few years have been a period of tremendous growth in index options. They are arguably the most liquid derivative markets in the world. As an example, the average daily volume for the NDX in June 2024 is up 133% relative to June 2022 and 32% higher than in June of last year. With the index measuring around 19,500, you’re able to get about $1.95 million dollars worth of notional coverage with a single NDX contract.

It’s not just the NDX price level that’s outpaced the competition. Our options volume has grown more quickly as well. Relative to June 2022, the S&P 500 Index Options volumes are up 26%. When compared to the previous June, volumes are slightly lower. Increasing competition in the index derivatives business is a benefit to end users.


Besides exposure to the NDX, Nasdaq-100® Index Options (NDX) offer end users a handful of unique attributes that other derivative products do not. For example, there are ETF options also designed to track the NDX. All ETF options are American styled, so there’s a risk of early assignment for option sellers. NDX Index Options, on the other hand, are European styled and cannot be assigned in advance of expiration. Furthermore, ETF options all physically deliver at expiration, which is different than index options, which are cash settled.

Some market participants are willing to accept ETF shares and manage the securities exposure associated with in-the-money expiring options. Others prefer the cash settlement associated with index products. There’s no portfolio disruption at expiration; simply an exchange of cash based on the settlement value of the option on the expiry date.

Source: Nasdaq Index Options

There’s also notional flexibility in the index options space. As mentioned, the full-sized NDX Index Options offer broad coverage (~$1.95m). That’s ideal for high-net-worth types and institutional clients looking to potentially enhance yield or protect against an adverse move for a large portfolio. For end users with a smaller wallet share, there are Nasdaq-100 Micro Index Options (XND). They are 1/100th the size of the full-sized product with the same potential benefits (cash settled, European styled and possible tax benefits). So, if an NDX contract affords ~$1.95 million in coverage, an equivalent XND Index Option would have ~$19,500 in notional exposure. It’s a much more approachable alternative for market participants with smaller accounts and an interest in index options. 

Finally, there are potentially meaningful tax benefits associated with index options vis-à-vis their ETF alternatives. Generally, index options are considered 1256 contracts. As such, no matter the holding period, they may be taxed at 60% long-term rate and 40% short-term. By contrast, ETF options are likely going to be taxed entirely at the short-term rate unless they are held for 365 days or more. It’s recommended that you speak with a tax advisor for more details on 1256 contracts.

If the Music Stops

Every bull market ends at some point. As discussed, the probability of selling out at or near the top is exceptionally small. Options, in general, and index options, in particular, afford market participants the ability to maintain exposure to their preferred index while managing the risk of a reversal with derivatives. There are unique risks associated with derivatives. Protective puts can be a performance drag during prolonged bull markets. There are tradeoffs in markets and in life.

Increasingly, investors are finding sophisticated ways to manage their exposure. Some finance the cost of downside protection by forgoing some upside participation (collars). Others reduce the dollar risk of downside protection by using NDX/XND put spreads. To be fair, that approach also limits the degree of protection. Still, others employ highly quantitative, systematic option overlay strategies to suit their portfolio needs.

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