Recently, we published a study exploring the behavior of short-dated straddles using Nasdaq-100 (NDX) options. That write up may be found here A Deep Dive Into Short Dated at-the-Money NDX Straddles. The motivation behind this work was the introduction of daily NDX option expirations along with the strong volume associated with these short-dated options.
To get a handle on how well these options were forecasting subsequent market moves, we priced 1, 2, 3, 4 and 5-day at-the-money straddles for every NDX PM settlement in 2022. We then calculated the performance of long and short straddles, including slippage for trading and commissions, if held through settlement. There were several findings, but the one that really stood out was the awful performance associated with selling straddles.
The table below shows the quarterly performance associated with buying and selling straddles for each time frame from 1 to 5 days over the past five quarters. Performance includes slippage of 2.00 points for each trade to account for market conditions.
As noted, performance in 2022 for selling straddles was awful. The common wisdom in the options market is that consistently selling options over a long period of time will result in profits, with periodic drawdowns in performance. The consistently bad performance during the first three quarters for all time frames in 2022 is counter to this thinking. We did notice that as the year progressed, short performance was improving, and it even turned positive for the 4-day and 5-day straddles.
However, the poor short straddle performance completely turned around in the first quarter of 2023. The 1-day time frame showed small profit and the longer the holding period the better the Q1 2023 performance. The first thought behind this change in performance is, “have the market makers gotten better at pricing these options?” However, it may be more than just that.
The next table shows the realized volatility for NDX by quarter over the same time period as we monitored above. Once again, the first quarter of 2023 is an outlier, but an outlier that may explain the performance of short straddles in 2023.
Realized volatility was much lower in the first quarter of 2023 versus each quarter in 2022. We believe this is a big contributor to the good short straddle performance for the first three months of this year. So, this leads us in another direction. Are very short-dated options a good method of taking advantage of a long or short outlook for volatility? Most traders appear to be using them for short term directional trading. However, there may be something for the volatility traders out there to explore with options that expire in just a day or so. We are going to explore this angle and report back as soon as we have findings to share.
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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