A Deep Dive Into Short Dated at-the-Money NDX Straddles

Abstract

The financial markets have experienced strong volume growth in the short- dated index option arena. This paper explores the performance of short-dated index options versus the subsequent price move in the Nasdaq-100 (NDX). The results show that consistent buyers of short-dated at-the-money straddles would have fared much better than sellers of these straddles in 2022.

Introduction

The option market has experienced incredible volume growth over the past few years. In 2022, a big portion of this growth came via index options, specifically in response to daily expirations now offered for markets like the Nasdaq-100 (NDX). Depending on the day, almost half NDX option volume may be in contracts expiring the same day.

If traders are not profiting from short-dated option trading it is unlikely the volume increase would match what was seen in 2022. To try to get a handle on what sort of strategies would have worked in 2022 we looked at short-dated option pricing versus the subsequent move in NDX. Our approach involves pricing the at-the-money straddle for short-dated options and comparing that pricing to the NDX close at expiration.

Methods

Straddles were priced using options that expire one to five days in the future. The straddle is priced with the mid-point of the bid-ask spread. The specific options used for each observation is the closest strike price to where the market closed on the day. NDX expiration on the third Friday of each month is at the market open (AM settlement) so those twelve observations were excluded from the study. The exit value for the straddle is calculated using the closing price for NDX versus the straddle strike price. These options are cash settled and no action is needed to exit the trade. No stop loss strategies were implemented so the straddle would be held through expiration.

We calculate a hypothetical profit or loss based on selling and buying the straddle. In each case we applied slippage of 2.00 points, to account for commissions and execution relative to the mid- point of the straddle spread. The following is an example of how the data for selling and buying the straddle is determined.

On May 11, 2022, NDX closed at 12345.85 and the closest strike price to this is 12350. The NDX May 12th 12350 Call mid-point is 151.15 and NDX May 12th 12350 Put mid-point price 158.05 which sums to 309.20 for the straddle. The following day NDX closed at 11967.56 which values the straddle at 382.44. The net result for a straddle seller is a loss, before adjusting for transaction costs, of 73.24. Of course, an individual on the other side of the trade would have a profit of 73.24. The result for a long straddle subtracts 2.00 points so the result is a gain of 71.24. The short straddle loses 75.24 after including 2.00 points of slippage to the trade.

Results

In 2022, there were 180 days with NDX options expiring on the close. For each tenor, one through five days, we recorded data as explained above and broke it down by the expiration day of the week as well as cumulative profits or losses for all expirations in 2022. Also, a few of these trades were priced in late 2021 using options expiring during the first days of January 2022. The outcome for each time frame shows the straddles consistently underpricing the subsequent price change by NDX.

Each table contains a variety of data. For clarity we briefly explain each column below.

• Weekday – day of week the option expires.
• Observations – number of trades that were observed on each weekday. Note Friday has only 40 observations as third Friday NDX options are AM settled. As noted for purposes of this study, we excluded those options.
• Inside Straddle – this figure shows the number of occurrences when NDX closed inside the range priced by the ATM straddle. This observation does not include any trading costs.
• Percent Inside – the percent of observations where NDX closed inside the range priced by the ATM straddle.
• Avg. Straddle Price – the average of the ATM straddle price as a percent of NDX
• Avg. Price Move – the average price change (higher or lower) as a percent of NDX
• Short Straddle Profit / Loss – profit or loss based on consistently selling the relevant straddles including slippage and commission costs.
• Long Straddle Profit / Loss – profit or loss based on consistently buying the relevant straddles including slippage and commission costs.

For each time frame we charted the profit or loss over the course of 2022 for both long and short straddle trades. The figures are adjusted for slippage and commissions. Also, in early 2022 there were not Tuesday or Thursday expirations so the are more daily data points for the third and fourth quarters than the first half of 2022.

Our initial interest was to only explore the price action for options that have one day to expiration. A good portion of trading occurs the day before expiration in the NDX complex, so we felt this was a good time frame to measure. However, after seeing the results below we decided to expand the study to include 2, 3, 4, and 5 days.

This first table shows just how underpriced 1-day NDX straddles were in 2022 with a consistent short straddle losing over 3,500 points. A straddle buyer would profit by just over 2,850 points in 2022.

One data point that caught our attention is the Monday results. The only 1-day option trade that made a profit on the short side in 2022 was selling an ATM straddle on Friday for Monday expiration. The average price change on Monday was +/-1.40%, the lowest of all five weekdays. The average Monday straddle pricing, at 1.51% of NDX, was in line with the average of 1.52% for all expirations.

The short straddle performance consistently trends lower after hovering around unchanged to start 2022. It is very difficult to find any period of more than a few weeks in 2022 when selling 1-day NDX straddles and holding them to expiration would make a profit.

The long side of this trade is a mirror image of the short side with long straddles performing quite well. The profits on the chart below finished 2022 just below the high for the year (3,126 points).

After analyzing the results for 1-day trades, we expanded the time frame to two-day trades. The common belief in the marketplace is that option sellers will be net winners over a long period of time. Based on this line of thinking, we expected the outcome for straddle sales to show a profit. However, our testing of 2-day NDX ATM straddles, just like the 1-day straddle results counters this line of thinking.

The short straddle loss of over 6,800 points is astounding. The straddles are consistently underpriced using the 2-day time frame with the average move of 2.41% much greater than the average pricing of 2.15%. Monday, which was a good day for 1-day straddles, is the second worst day for 2-day straddles, a function of Fridays being the most volatile day of the week with an average move of +/-1.88% (previous table).

If there is any bright side for straddle sellers is that the performance flattens out over the last three months of 2022. This may indicate market makers are becoming more skilled at managing their risk around shorter dated options.

Buying 2-day straddles on NDX would have been a great strategy for the first six months of 2022. Performance was range bound toward the end of the year.

There is a little improvement for straddle sellers when we look to 3-day trades versus the horrendous results for selling a 2-day straddle. However, this time frame is still a net loser and is worse than the 1-day trades, with a net loss of 4,683 points.

The average straddle pricing by weekday is consistent between 2.60% and 2.67%, but the 3-day price changes cover a much wider range, with Wednesday at the low end (+/-2.44%) and Tuesday at the high end (+/-3.33%). Wednesday and Thursday were good days to sell straddles as those two days experienced the lowest average price changes.

The trend on the following chart is to the downside, but appears to moderate and flatten as we get to the end of 2022. There is a period between October 12 and November 1 where 2,000 points of profits would be realized by straddle sellers. However, that short-term gain disappears by the end of 2022.

Buying 3-day straddles worked well in the beginning of 2022. However, the profit for the year is about 1,000 points lower than the peak return. Also, there is over a 2000 point drop in P/L over the period of time where the short straddle results were strong.

The 4-day ATM straddle results for seller is better than the 1, 2, and 3-day trades, but it is still a loss of over 2,100 points. A straddle buyer would profit by a tad over 1,400 points. Note, like the 3-day trades, the midweek (Wednesday and Thursday) results for straddle sellers are positive.

We found the pricing for Friday straddles interesting as it is much lower than the other four expiration dates. The other four days are in a tight range while Friday pricing is at least .10% lower than each of those days. Even though the straddles are priced lower, the average 4-day move is in the middle of the average price moves at 3.15%.

The short performance chart using 4-day straddles is trendless. In fact, if a trader consistently started selling 4-day ATM straddles in early September and continued to do so through the end of 2022, their profit would be over 2,000 points.

Consistently buying a straddle results in a gain of 1,400 points. This figure is much lower than the peak profit of 3,858 from early September. That represents a drawdown of 63% from peak performance in 2022.

Finally, we explored 5-day ATM straddles. Note the average straddle price is 3.34% of the NDX level. This is the same as the price changes for the underlying market. A straddle seller would lose 1,565 points and a consistent buyer of a straddle gains 845 points.

Unlike other time frames, the 5-day straddle expiring on Friday was profitable, along with Tuesday and Thursday.

The short straddle performance is similar to the 4-day returns. In fact, a seller of 5-day ATM NDX straddles would be down over 5,000 points in early September and finish the year recouping about 3,500 points over the last four months of 2022.

Buying 5-day straddles worked well for the first few months of 2022, with performance peaking at just over 4,600 points before giving up about 3,800 points over the last few months of 2022.

Shorter Time Frames

While working through the annual charts we noticed periods where short performance was positive, especially for the 4-day and 5-day time frames. This led us to explore shorter time frames for each of the straddles discussed in this paper. The following table breaks down each time frame by quarter.

Although both quarterly long and short performance is depicted, we will focus on the short performance by quarter. We went into this study believing short straddles would yield profits. The 1-day short straddles are consistently bad across all four quarters, with the second worst quarter being Q4. A pattern starts to emerge when looking at 2-day and 3-day performance as the first half of 2022 was terrible for both while the second half realized losses were a fraction of the losses witnessed in the first half of the year. Finally, both the 4-day and 5-day short performance is positive in Q4, which is no surprise after seeing the profit and loss charts in the previous sections.

Summary

The belief that over a long period of time options sellers do better than options buyers did not hold up well using NDX option pricing in 2022. This may be a function of excess volatility in 2022, but for the 1-day time period the trend was consistently higher losses over the course of the year. After breaking down quarterly performance for the other time frames it does appear the pricing of these ATM straddles is becoming more efficient with lower losses or even gains during the second half of the year for 3-day, 4-day, and 5-day straddles. Our plan is to revisit the data on a quarterly basis to see if that trend continues.

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