Combining NDX and NVIDIA Option Positions Around NVIDIA Earnings

NVIDIA (NVDA) is set to report earnings on Wednesday May 28 after the market close. As a large component of the Nasdaq-100 (NDX) we dug into NDX and NDX option price action around NVDA earnings and found a method of trading NVDA earnings combining NDX and NVDA short-dated option positions.

NVDA currently holds the distinction of being the second largest component in the Nasdaq-100 (NDX) falling between Microsoft (MSFT) and Apple (AAPL). The company also reports earnings outside of the traditional earnings season, a couple of weeks after the other large NDX components have reported. This offers a chance to analyze NDX price action around NVDA earnings without earnings from other large NDX components influencing the price action. 

Our method of tracking earnings involves the previous twelve reports calculating the average move on an absolute value basis, comparing recent report reactions to that average, and tracking the nearest expiring at-the-money (ATM) straddle pricing the day before and day after a stock’s reaction to earnings. The table below is a summary of that data for NVDA and NDX.

Data Sources: Bloomberg & Author Calculations

NVDA reports on Wednesdays after the market close, so the options used to trade NVDA earnings expire in 2 days. Although NDX has daily expirations, we use NDX options expiring in 2 days for a more direct comparison with NVDA option activity.

The average move on NVDA earnings day for NDX is +/-1.45% and +/-7.72% for NVDA. NDX and NVDA were both lower on the day NVDA reported in the previous quarter, to an extent that is greater than the average move. For option activity, we price the ATM straddle the day before and day after earnings. Both NDX and NVDA ATM straddle have overpriced seven of the last twelve (58.33%) and consistent sellers of those straddles would make small profits.

The next graphic is a break-down of NVDA’s price reaction to earnings reports. Note most of the biggest moves have been to the upside, with last quarter’s report representing the worst reaction to earnings in the last three years.

Data Sources: Bloomberg & Author Calculations

The next graphic shows the ATM straddle pricing on the close before earnings and on earnings reaction day. Despite NVDA shares losing more than the average move last quarter, a straddle seller would have made a profit of 1.00 (11.85 before / 10.85 after) based on closing prices.

Data Sources: Bloomberg & Author Calculations

The average price change for NDX on NVDA earnings reaction days has been +/-1.45% which is slightly higher than the average price change for NDX over all days in the same period of +/-0.89%. NVDA earnings day does have an impact on NDX price changes.

Data Sources: Bloomberg & Author Calculations

Remember from the table above, NDX straddles have overpriced seven of the last twelve price changes on NVDA earnings day. However, last quarter a seller of the 2-day ATM straddle would realize a significant loss, unlike the seller of the NVDA straddle.  

Data Sources: Bloomberg & Author Calculations

Seeing the diversion between NVDA and NDX straddle pricing last quarter led to exploring combining short straddles from both markets. Our approach to combining NDX and NVDA straddles has 50% exposure to each. As the notional price of NDX options is much higher than that of NVDA, a single NDX straddle is priced and then the number of NVDA straddles is determined by dividing the NDX straddle premium by the NVDA straddle premium. For example, last quarter the NDX straddle was priced at 387.25 and NVDA at 11.85. The result is selling 1 NDX straddle and 33 NVDA straddles. Each trade outcome applying this method appears below.

Data Sources: Bloomberg & Author Calculations

The net result behind this approach is an improvement of profitable days to eight from seven for both the individual market results. Also, the net profit from this approach is 337.05 points. Since most traders would not look to selling straddles with hundreds of points of risk, we applied a slightly different approach using Nadaq-100 Micro Index (XND) options.

XND options are 1/100^th the size of NDX options. Our approach using XND options was to sell five XND ATM straddles and then divide the NVDA straddle premium into that figure to determine the number of NVDA straddles. For example, the XND ATM straddle is priced at 3.88 last quarter, five of those sums to 19.36. The NVDA straddle price is 11.85 which is about 2 NVDA straddles for 5 XND straddles. The results of applying this method to combining NVDA and XND straddles appear below. The net result in this case is a net profit of 4.58 and profits eight of twelve reports, which is slightly better than the result for trading with just NVDA straddles.

Data Sources: Bloomberg & Author Calculations

This week, around NVDA earnings, option traders have more alternatives than just trading NVDA options by looking to NDX and XND contracts. The final trade will be based on what option pricing is anticipating as the NVDA earnings announcement approaches. Traders may consider NVDA, NDX, XND, or a combination of these contracts based on their outlook for the markets in reaction top NVDA earnings.