NDX At-the-Money Straddles Underpriced Last Four Payroll Reaction: Will the Streak Continue?

One of the benefits of multiple option expirations in the index option space is the ability to pinpoint expectations around significant economic events. This Friday (June 7), the Bureau of Labor Statistics will release the May Non-Farm Payroll report which contains a slew of data and is considered a first look at economic activity during the previous month.

Option traders often speculate on the magnitude of the move with the At-The-Money (ATM) straddle offering insight to how volatile traders expect the reaction. The chart below shows 1-Day NDX ATM straddle prices as a percent of NDX using closing prices on the day before the payroll report.

Data Sources: Bloomberg & Author Calculations

The average straddle pricing over these twenty-eight observations (the report on April 7, 2023, was on a stock market holiday) is a move of +/-1.34%. To put this +/-1.34% in perspective, the average NDX 1-Day ATM straddle over the same period priced a move of +/-1.09%. This figure was higher in 2022 and the first three months of 2023. A more recent average, using the last twelve reports the average is exactly +/-1.00%, which is 0.21% higher than the 0.79% average for all days over this period.  This compares to +/- However, the last four reports saw the straddle priced at or above this average after the lowest pricing in our lookback period of +/-0.78% for the January 5, 2024, report.

There is a reason the more recent straddle pricing is trending higher. Specifically, as noted in the title of this article, the straddle has underpriced the last four reactions. The chart below displays data determined by subtracting the price change on payroll day from the pricing of the ATM straddle.

Data Sources: Bloomberg & Author Calculations

From a trader’s perspective the best way to think about this graphic is option sellers likely lost money when the straddle underprices the move and profits when the straddle overprices the move. The straddle is overpriced 60.71% of the observations above and underpriced on 39.29%.  Despite being overpriced more often underpriced, a trade that consistently sells a 1-Day ATM straddle before the payroll report and holds it through the close would have lost just over 280 points or an average of 10 points a trade.

Based on the four-period losing streak for short straddles, we will be looking for elevated option premiums going into the close Thursday, whether it will be enough to cover Friday’s reaction will determine if the streak extends to five days or not.