The Consumer Price Index (CPI) and associated data will be released Thursday August 10 before the market opens. CPI is a major inflation gage and for a few months in 2022 and early 2023, financial markets were focused on the Fed’s battle with inflation, so this monthly figure had the market pausing like commodity traders in front of a major crop report (people of a certain age know this reference).
The table below shows the NDX price reactions over the past twelve CPI releases. Note the average is +/-2.24%, but that figure has not been exceeded since March this year. A better average move to work with may be the 2023 reactions with an average of +/-1.08%.
Data Source: Bloomberg
In addition to tracking one day reactions to major economic events, we trade the 1-day at-the-money ATM straddle pricing. The figure below shows the ATM straddle the day before and upon settlement for the last twelve CPI releases.
Data Source: Bloomberg
The dark bars represent the straddle pricing before the CPI report. Note this figure has trended lower due to a lack of outlier moves since November 2022. Also, of interest, despite the May 10 and July 12 reactions falling below the longer-term average move, the ATM straddle underpriced the CPI reaction.
Out of curiosity we priced our favorite neutral index option trade around the July 12 CPI release, an iron condor. Using the 2.24% average move to choose the short strike prices and then going out 10 points to buy the wings of the spread would result in receiving a credit of 0.62 for the NDX Jul 12th 14770 / 14780 / 15460 / 15470 Iron Condor. The payout on the following day’s close appears below.
Data Source: Bloomberg
The risk for this trade is a loss of 9.38 if the average move was exceeded by 10 points in either direction. That did not happen, so this would have been a successful trade, but the 9.38 risk for a 0.62 reward may not be appropriate for everyone.
A long volatility spread, where a trader expects a bigger move from NDX relative to what the market is pricing in could be traded a variety of ways. We decided to buy the 0.50% out of the money call and put, as that is the smallest move in the last twelve months and sell the farther out of the money call and put based on the average move of 2.24%. This would result in buying the NDX Jul 12th 15040 Put and 15190 Call and selling the 14780 Put and 15460 Call for a net cost of 84.00. The payoff at the close for this trade appears below.
Data Source: Bloomberg
This trade pays off 176.00 if there is a move that places NDX lower than 14780 or 186.00 if NDX is higher than 15460. The break-even levels for this trade require a move of about +/-1.08%, slightly higher than the average 2023 NDX reaction to CPI. The result, based on NDX closing at 15307.23, is a profit of 33.23 with the long call 117.23 in the money.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Russell Rhoads, PhD, CFA
Russell Rhoads, Phd, CFA is a highly regarded strategist, educator, and consultant – among other things he is perhaps best known as the author of Trading VIX Derivatives, the textbook in the space.
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