Nasdaq 100 — U.S. High-Tech Index

NASD launched the Nasdaq 100 in late January 1985. It was the second technological index. The formal leadership belongs to the NYSE ARCA Tech 100 Index. It was launched in 1982.

The developers deliberately decided to make it a technology index; for this purpose, the financial sector was excluded from the basket. In the beginning, only American companies were included in the basket, but since 1998 the rules were relaxed, and now foreign companies’ securities can be included too. NDX futures includes stocks of the planet’s major technology giants. This explains the impressive capitalization, with more than $15 trillion in capitalization as of the end of 2020.

Due to the strong growth of the IT sector, the TR version overtook the S&P 500 TR regarding returns from 2008 to 2020 by nearly half. Increased demand for technology stocks in the past decade explains this divergence.

It was more vulnerable at an earlier stage of development. For example, after the dot-com crash, quotations fell about 6 times, and it took about 14 years to recover. This is the main disadvantage — it is insufficiently diversified and critically dependent on the growth of the high-tech sector.

There are standard subspecies — Total Return (considering reinvestment of dividends) and Net Total Return (dividends are also reinvested, but considering payment of taxes). The basket and method of calculation of quotations do not change; there is always a 100% direct correlation between the listed versions.

Nasdaq index futures: composition of the basket 

The composition of the Nasdaq index futures proves the dominance of the high-tech sector:

• If we evaluate individual companies, the league weight of Apple, Amazon and Microsoft exceeds 30%. It is Thanks to these three that strong growth in the second half of the tens was provided.
• In all, the technology sector accounts for more than 50% of the basket. Formally, the healthcare and telecom sectors are also present, but their shares are small and do not greatly influence the quotes.
• The composition of the basket is not fixed; companies may “drop out” of the composition if they no longer meet the requirements. The only thing that does not change is the number of components, which corresponds to the numerical index. The full list of companies is available on the provider’s website.

The approach to the formation of the basket has been criticized. The developers have failed to cope with the overheated growth of the high-tech sector. Because of this, calculating the quotes had to be interfered with several times in the past. In 1993 and 1994, the provider manually lowered quotes in an attempt to deal with overheating due to the accelerating growth of the IT sector. At the time, this put the Nasdaq 100 futures life in question. 

Stock selection criteria

The index design document outlines a whole set of requirements that must be met by securities that qualify for inclusion in the basket. Below is a brief overview of those criteria:

• The basket can include ADRs, ordinary shares, and so-called tracking stocks (a type of stock issued for subsidiaries).
• A U.S. company must be listed on the Global Select Market/Nasdaq Global Market.
• Non-U.S. companies must have options traded on U.S. exchanges or at least meet the requirements to do so.
• Only non-financial companies are considered.
• Average daily traded volume of stock must not fall below 200,000 securities for at least three calendar months. The month in which the composition of the basket is reviewed also counts.
• Shares must be traded on one of the following venues — Nasdaq Global Select Market, Nasdaq Global Market/Nasdaq Capital Market, CBOE BZX, NYSE. The securities must have been traded on that floor for at least 3 months before the committee meeting. The month in which the listing occurred does not count.
• The committee does not consider companies that are in bankruptcy.
• There are no minimum capitalization and free-float requirements. But, given the other requirements, small businesses have no chance of being in the basket.

Reviewing the composition of the basket

There are clear revision regulations:

• On the eve, a list of the top 100 companies by capitalization that meet all the criteria is lined up. From this list, companies ranked number 1 through 75 are automatically included in the basket.
• The rest of the list of 76th-100th place is evaluated. If companies from this segment have been in the basket before, they are also included in the basket.
• Sometimes there are no 100 companies after the first 2 steps. In this scenario, positions 100 through 125 are evaluated, and if there are stocks in this segment that were previously in the top 100 by capitalization, they are added to it.

If even that is not enough to form a basket, the remainder is filled with the remaining companies from the Top 100 list.

There are strict timeframes, too:

• The revision of the basket is performed on the third Friday of December; this procedure is performed once a year.
• The data on shares outstanding as of the end of November is used. Other securities characteristics are taken as of October.

In addition to reviewing the composition of the basket, rebalancing — a review of the “weights” of individual companies — is also performed. Rebalancing is done on a quarterly basis, and the logic is as follows:

• If a company’s “weight” does not exceed 24%, no changes are made. Otherwise, the “weight” is reduced based on the logic of no more than 20% per company.
• The total proportion of shares whose “weight” exceeds 4.5%, but corresponds to the previous point, must not exceed 48%. Otherwise, rebalancing takes place so that these companies do not collectively account for more than 40%.

There is also an annual rebalancing, with slightly different criteria:

• The share of individual companies is assessed, and it must not exceed 15%. If the threshold is exceeded, the “weight” of the shares is reduced to 14%.
• The aggregate “weight” of the 5 largest companies by capitalization is evaluated, and it must not exceed 40%. If this requirement is not met, then rebalancing is carried out and their combined share is lowered to 38.5%. Also, the “weight” of one company cannot exceed 4.4%, or the “weight” of the 5th most capitalized company in the basket.

Despite these rules, the index is poorly diversified. Even with this approach, the 3 largest companies account for about 30% of the basket.

Nasdaq futures now — conclusion

Cryptocurrencies aside, this instrument has become one of the most profitable over the past decade. This is due to the growth of the IT segment, but does not guarantee the same returns in the future. History shows that the index is painfully responsive to the tech sector, a key risk. Otherwise, Nasdaq futures are a great tool for both investing and active trading.