Abstract Tech

Nasdaq-100 Options Have Been Underpricing FOMC Day, Will This Repeat This Week?

Russell Rhoads
Russell Rhoads, PhD, CFA Associate Clinical Professor of Financial Management at the Kelley School of Business at Indiana University

The FOMC could make the final full trading week of the year interesting this coming Wednesday with the last rate decision of 2024. Derivative pricing indicates at 99.1% chance of a 25-basis point cut, so any volatility will come from the statement. That is as long as they cut by the expected 25-basis points. Surprises do not seem to be part of Powell’s playbook, so it’s unlikely the amount of the cut will cause any reaction from the financial markets.

We track the index option markets around major economic releases like stock analysts track earnings reactions. The figure below shows the NDX price reaction for the last twelve FOMC announcements.

Data Sources: Bloomberg & Author Calculations

The average Nasdaq-100 (NDX) price change over the last twelve FOMC days was +/-1.31%. It I no surprise that average price changes on FOMC day are higher than average price change for NDX over all trading days. For example, the average daily price change for NDX has been +/-0.85% over all trading days covering the same period.

Despite the knowledge that the FOMC day is more volatile than other days, the NDX option market has underpriced eight of the last twelve FOMC trading days. NDX premiums will be elevated going into Wednesday, especially those NDX options expiring that afternoon. The figure below shows the premium for the 1-Day at-the-money straddle the day before and upon settlement on FOMC day.

Data Sources: Bloomberg & Author Calculations

The dark blue lines in the graphic above represent the 1-Day ATM straddle pricing, using the mid-point of the bid-ask spread, on the close the day before the FOMC announcement. The light blue line is the settlement value for the same 1-Day straddle on FOMC day. NDX option sellers have had a difficult time on FOMC days, especially the July 31 announcement. The straddle was priced at 306.95, the highest level of the past twelve straddles, but that was not enough as NDX was up 3% that day.

A trader that consistently sold the NDX ATM straddle in the manner above over the last twelve FOMC days would be down 435 points and have only profited four times, with two of those observations coming at the beginning of the time frame covered. 

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