The index options market developed as a tool for managing risk. Traders could add exposure to the market by buying options, hedge exposure by selling options, or try to capture income from a "Buy-Write" strategy. Generally speaking, options traders didn't care which way the market was moving, as long as it was moving.

The new natural gas index from International Securities Exchange (ISE) turns that all on its head.  Rather than trying to capture the maximum movement in the market, the index has screens that dampen volatility.  Rather than simply trying to track the market, the index tries to beat it.

Developed in partnership with Revere Data, and launched on October 10, this index is the ISE's first foray into the  "enhanced indexing" field. It is also a sign of the times, showing that the options industry is reaching out beyond its traditional customer-base and targeting retail-oriented long-term investors.

Selecting For Performance

It is not surprising that the ISE developed a natural gas index.  Like most commodities, natural gas is a hot topic, and the ISE has been aggressively expanding its index business into hot new areas for the better part of the decade.

"We look at a variety of things before we move forward with a new index," says Kris Monaco, who heads up the index development business at ISE.  "What's in the press, what people are talking about, what's tradable… Commodity prices are headline news, and this seemed like a specific sector that we could target to further ISE's brand, and also to create an interesting tradable product."

But the new index is not a straight natural gas index … not by a long shot.  In addition to some nifty data mining by Revere Data that aims to separate real natural gas companies from integrated energy firms (more than 50 percent of a company's proven energy reserves must come from natural gas), the index features a four-part screening test that tries to pick out stocks that will perform well in the market. Call it an alpha-seeking index, a fundamental index or an enhanced index; the point is that this index, like the bogies behind the PowerShares ETFs, selects for performance.

"The intent (of the index) is really not to mirror the price of natural gas," said Monaco. "But to capture the growth of this sector.  The question was: how do you come up with a really good group of stocks - a high-quality portfolio - that could really take advantage of this growth sector?"

1 | 2 |