Reconfiguring the NASDAQ 100 Index

By Scott "The Strategist" Fullman
December 18, 2001

The NASDAQ 100 Index (NDX) has become one of the most popular instruments in the investment industry during the past several years. NDX was developed as an index option product, allowing investors and traders to focus on the top 100 stocks traded on the NASDAQ, similar to the S&P 100 Index (OEX). As popularity of this product has grown, the different exchanges have introduced other products based on NDX.

Each year, the National Association of Securities Dealers adjusts the components of the NASDAQ 100 Index to reflect current market conditions. This is in addition to adjustments that are made during the year that were made due to acquisitions or de-listings. The annual revision is announced at the end of December for the new calendar year. Today the adjustments were released, which will take effect on December 24, 2001.

NDX is a capitalization-weighted index, meaning that a given change in the largest capitalization stock in the index will result in the greatest change in the index value. Microsoft Corp. (NASDAQ-MSFT) is the largest stock in the index, representing almost 12% of the index. The second largest component is Intel Corp. (NASDAQ-INTC), which has a 6.1% weighting. Excite@Home (NASDAQ-ATHMQ), which filed for Chapter 11 bankruptcy protection, and is currently closing down operations, has a zero weighting, the lowest of the component issues.

A weekly chart on the NASDAQ 100 Index
Figure I - A weekly chart on the NASDAQ 100 Index from January 2000 to the beginning of December 2000.

Market conditions during the past 1 3/4 years have resulted in a larger-than-usual number of adjustments. These adjustments will have several implications for the trading and movement of NDX. Prior to the adjustments the technology sector represented nearly 69% of the weight in the index. This sector accounted for the largest portion of negative performance among the six sectors. Basic materials has the lowest representation, with only one issue, OR 0.4% of NDX.

THE CHANGES

Of the 100 issues that comprise the NASDAQ 100 Index, the following deletions and additions were made:

Deletions
Ariba Inc. (ARBA)
BroadVision Inc. (BVSN)
CMGI Inc. (CMGI)
CNET Networks Inc. (CNET)
3Com Corp. (COMS)
Inktomi Corp. (INKT)
Level 3 Communications (LVLT)
McLeodUSA Inc. (MCLD)
Metromedia Fiber Network (MFNX)
Novell, Inc. (NOVL)
Palm Inc. (PALM)
Parametric Technology Corp. (PMTC)
RealNetworks Inc. (RNWK)
Additions
ImClone Systems Inc. (IMCL)
Charter Communications (CHTR)
CDW Computer Centers (CDWC)
Symantec Corp. (SYMC)
Sepracor Inc. (SEPR)
Invitrogen Corp. (IVGN)
Express Scripts Inc. (ESRX)
Cephalon Inc. (CEPH)
ICOS Corp. (ICOS)
Cytyc Corp. (CYTC)
Protein Design Labs Inc. (PDLI)
Integrated Device Technology Inc. (IDTI)
Synopsys Inc. (SNPS)

WHAT THE CHANGES MEAN

As we mentioned at the beginning of this report, there have been several investment products that are based on the NASDAQ 100 Index. These products include the NASDAQ 100 Index Tracking Stock (QQQ) [currently with $22 billion in assets], a very popular Exchange Traded Fund; options on QQQ; The Mini-NASDAQ 100 Index (MNX), a reduced value index option product; and the NASDAQ 100 Futures contract.

Since the changes in the component issues will result in the entrance of stocks with lower volatility levels compared to the stocks that will be removed from the index, we can predict that the newer version of NDX, and other products based on it, will have lower volatility levels as well. This should translate into lower time premiums for the option contracts on those products.

Additionally, the sector weighting of the index will shift from a very high concentration in technology issues to more of a mixed weighting between the technology and biotechnology sectors.

In addition to the other instruments that are based on NDX, the Chicago Board Options Exchange (CBOE) has introduced an index (VXN) to measure the implied volatility of NDX, based on the premiums of the option contracts. The adjustments to the component issues will likely cause VXN to be reduced. Additionally, the American Stock Exchange (ASE) has calculated the NASDAQ 100 Index Tracking Stock Implied Volatility Index (QQV), which measures the premiums of the option contracts on QQQ. A similar reduction is anticipated for this indicator.

Daily chart on the NASDAQ 100 Implied Volatility Index
Figure II - Daily chart on the NASDAQ 100 Implied Volatility Index (VXN).