Watch This Before You Buy Options | Options Backtest

Summary

The transcript discusses the impact of quarterly option expirations on market volatility. It highlights that while quarterly expirations, known as 'triple witching,' tend to be more volatile than average days, the market effectively adjusts for this, pricing in the expected increased movement. The study analyzed 20 years of S&P 500 and VIX data, comparing actual moves to expected moves based on the VIX. The findings suggest that although there is a higher percentage of significant moves during quarterly expirations, the market's ability to price volatility means that no actionable edge is provided by these events.

Takeaways

• 📈 Market makers adjust their positions during quarterly expirations, potentially impacting supply and demand for shares.
• 📊 The study analyzed 20 years of S&P 500 (SPY) and VIX data to measure market volatility around quarterly option expirations.
• 🔢 Daily, weekly, and bi-weekly market moves were compared as raw percentages and multiples of the VIX's expected move.
• 🌪️ One-day market moves greater than 1% occurred 26% of the time, while two-week moves greater than 1% happened 70% of the time.
• 📈 2% market moves happened daily 7% of the time, weekly 29%, and bi-weekly 43%. For quarterly option expirations, these numbers increased.
• 🔄 The market's volatility is priced in, with the actual moves during quarterly expirations aligning closely with expected moves based on VIX.
• 💡 The study suggests that while there is increased volatility around quarterly expirations, the market efficiently adjusts for this.
• 🚀 Triple witching, a term used for quarterly expirations, is characterized by large notional values, with the current figure being around five trillion.
• 🤔 The perception of increased market activity during quarterly expirations may not always translate to significant tradable differences.
• 🛠️ Market participants should be aware of the additional risk and premiums during quarterly expirations, but these are already factored into market prices.
• 📉 The study found no significant difference in overall market moves when adjusted for the expected volatility derived from the VIX.

Q & A

What is the significance of the term 'triple witching' in the context of the market?

Triple witching refers to the quarterly expiration of stock index futures, stock index options, and single stock options. It is a significant event that can lead to increased market volatility due to the large notional value involved in these derivative contracts expiring on the same day.

How do market makers attempt to manage their positions during option expirations?

Market makers manage their positions by being the counterparty to the option positions traders wish to take and by remaining as hedged as possible. They typically do this by using long and short positions to cancel out the Deltas from their option positions.

What was the purpose of the study mentioned in the transcript?

The study aimed to determine if there is a noticeable difference in market volatility during quarterly option expirations compared to other expirations such as daily, weekly, or monthly ones.

How much data was used in the study to analyze market volatility?

The study used 20 years' worth of data from the S&P 500 (SPY) and the CBOE Volatility Index (VIX) to analyze market movements and volatility during option expirations.

What did the study find regarding the frequency of market moves greater than 1% during quarterly option expirations?

The study found that during quarterly option expirations, the frequency of market moves greater than 1% increased to 28% on a daily basis, 56% on a weekly basis, and 70% over two weeks, compared to the average days.

How did the study measure market volatility?

The study measured market volatility by looking at the raw percentage moves of the market and comparing them to the expected moves derived from the VIX, which is a measure of market-implied volatility.

What was the conclusion of the study regarding the market's adjustment to volatility during quarterly expirations?

The study concluded that the market adjusts perfectly for volatility during quarterly expirations. While there was a noticeable increase in actual market moves during these periods, the expected moves, as indicated by the VIX, were also higher, indicating that the market prices in the additional volatility.

What does the transcript suggest about the market's intelligence?

The transcript suggests that the market is highly intelligent, as it effectively prices in the expected volatility and adjusts for the additional risk and premiums associated with quarterly option expirations.

What advice does the transcript give to retail traders regarding quarterly option expirations?

The transcript advises retail traders to be aware of the additional risk and premiums associated with quarterly option expirations, but also reassures them that these factors are already accounted for in the market prices.

How does the transcript describe the relationship between market volatility and expected moves?

The transcript describes the relationship between market volatility and expected moves as closely aligned. Volatility, which is essentially the expected move, is already factored into the market's pricing, which is why the actual moves during quarterly expirations largely match the expected moves based on the VIX.

Outlines

00:00

📈 Market Volatility During Quarterly Expirations

This paragraph discusses the impact of quarterly option expirations on market volatility. It highlights the concept of 'triple witching,' a term used to describe the largest quarterly expirations, which are expected to be the most volatile. The conversation explores whether these quarterly expirations are indeed more volatile than other expirations and how market makers adjust their positions to remain hedged. The paragraph also presents a study using 20 years of data on S&P and VIX to analyze the difference in market moves during quarterly expirations compared to an average day. The findings suggest that while there is an increase in volatility around quarterly expirations, the market effectively adjusts for this, pricing in the expected volatility.

05:01

🔍 Analyzing Market Adjustments to Quarterly Expirations

The second paragraph delves into the analysis of how the market adjusts to the increased volatility around quarterly expirations. It compares the actual market moves to the expected moves based on the VIX, which measures expected volatility. The study's results indicate that the market does an excellent job of pricing in the additional risk and premiums associated with quarterly expirations. Despite the higher percentage of moves greater than 1% and 2% during these periods, the market's pricing mechanism accounts for this, making the difference statistically insignificant when looking at expected moves. The key takeaway is that while quarterly expirations can be more volatile, market participants are aware and the market reflects this in its pricing.

Keywords

💡quarterly expiration measurements

The term refers to the analysis of market behavior during the quarterly expiration of financial options and other derivatives. In the context of the video, this concept is central to understanding the study's focus on how quarterly expirations impact market volatility compared to other expiration cycles.

💡market maker

A market maker is a financial institution or individual trader who provides liquidity in the market by continuously quoting bid and ask prices for a particular security. In the video, market makers are described as entities that adjust their option positions to remain as hedged as possible, which can influence market supply and demand.

💡triple witching

Triple witching refers to the simultaneous expiration of stock index futures, stock index options, and options on futures, which typically occurs on the third Friday of the expiration month. This event can lead to increased market volatility due to the large number of contracts expiring at once.

💡volatility

Volatility in finance refers to the degree of variation of a trading price series over time as measured by the standard deviation of returns. In the video, volatility is used to quantify the expected movement in the market and is a key factor in understanding how the market behaves during quarterly expirations.

💡VIX

The VIX, or CBOE Volatility Index, is a real-time market index that represents the market's expectation of 30-day forward-looking volatility. It is derived from the price of S&P 500 index options and is often referred to as the 'fear index' because it tends to rise when investors are more fearful of market declines.

💡notional value

Notional value refers to the total value of a financial instrument or derivative, which is the amount on which interest payments, gains, or losses are calculated. In the context of the video, it is used to describe the magnitude of the financial impact of the quarterly option expirations.

💡Delta hedging

Delta hedging is an options trading strategy that involves adjusting the position in the underlying asset to offset the risk of price changes in the options being held. The delta measures the sensitivity of an option's price to a $1 change in the price of the underlying asset.

💡expected move

The expected move is a term used in the context of options trading and volatility, referring to the anticipated change in the price of an underlying asset based on the implied volatility of the options. It is a forward-looking estimate of market movement.

💡market adjustment

Market adjustment refers to the process by which the market incorporates new information or events into the prices of securities. In the context of the video, it relates to how the market accounts for the additional volatility during quarterly option expirations.

💡liquidity

Liquidity in financial markets refers to the ease with which assets can be bought or sold without affecting the asset's price. High liquidity typically means that there is a large volume of buyers and sellers, resulting in minimal price impact when trades are executed.

💡risk premium

A risk premium is the additional return an investor expects for taking on increased risk in an investment. It compensates the investor for the possibility of loss above the expected return. In the context of the video, risk premiums are discussed in relation to the additional risks market participants may face during quarterly expirations.

Highlights

The study focuses on the volatility of quarterly option expirations compared to other expirations.

Triple witching, a quarterly expiration, is expected to be the largest in notional value, with five trillion mentioned in the discussion.

Market makers aim to be the counterparty to option positions and remain as hedged as possible by using long and short to cancel Deltas.

The study used 20 years of data from the S&P 500 (SPY) and the CBOE Volatility Index (VIX) to analyze market movements.

The VIX has been around for a little over 20 years and measures the expected move in the market.

The research compared raw percentage moves and multiples of the VIX's expected move for the SPY on a daily, weekly, and bi-weekly basis.

The frequency of market moves greater than 1% was found to be 26% for one day, 56% for one week, and 70% for two weeks.

For option expiration on a quarterly basis, the frequency of moves greater than 1% is notably higher.

Market volatility increases around quarterly expiration cycles, with 2% moves occurring 8%, 29%, and 35% more frequently over one day, one week, and two weeks, respectively.

The market adjusts for the increased volatility around quarterly expirations, pricing in the expected moves.

The study found no significant difference in market moves when adjusted for volatility, indicating markets price in the expected volatility.

Retail traders can benefit from the liquidity provided during quarterly expirations but should be aware of the additional risk and premiums.

The discussion highlights the intelligence of the market in pricing in expected volatility, showing that markets are efficient.

The actual market moves during quarterly expirations show a significant difference compared to expected moves, but this is already priced in by the market.

The study's findings suggest that while quarterly expirations result in more volatile markets, the market efficiently accounts for this volatility.

The research provides insights into the behavior of market makers and the impact of their adjustments on supply and demand for shares during option expirations.

The transcript serves as a valuable resource for understanding the dynamics of market volatility and the role of quarterly option expirations.

Transcripts

quarterly expiration measurements

quarterly expiration measurements

interesting piece it's a new market

measure sponsored by the sibo let's see

what we got Market maker today's today

is triple witching it is the quarterly

expiration so we found we thought it

would be fun to take a look and see how

much more volatile is quarterly

expiration from all other expirations

daily weekly monthly whatever you know

how how is this day different from all

other

that's right that's right market makers

do their best to both first to be the

counterparty to whatever option position

Traders wish to take and then second to

remain as hedged as possible typic

typically by using long and short to

cancel Deltas from their option

positions because of this in principle

market makers adjusting their option

their option expiration dates might have

an outsized impact on supply and demand

for shares because quarterly option

expirations are typically the largest in

notional value today they were talking

about five trillion weren't

they notional this yeah we would expect

this the biggest ever right yeah we

would expect this to be noticeable as

March quarterly expiration is near has

this period been measurably different

for the overall Market has this period

of triple witching and then coming com

up the quarterlies in 2 weeks has this

been noticeably different for the

overall market like is there going to be

more volatility what do you think from a

volatility standpoint you're going with

now right volatility market movement yes

I'm gonna say no Thomas I'm G take a

shot I don't really know I didn't really

know either let's go to the next

slide so we did a study we used 20 years

worth of data in the spy and the vix I

think the vix oh yeah the vix has been

around for a little over 20 years right

we considered the Spy daily weekly and

bi-weekly moves both as a raw percentage

and as multiples of the Vic's derived

expected move so we looked at them

basically just raw moves and whatever

the expected move was as as dictated by

vix all volatility is is just another

word for expected move we contrasted

these results from the past 80 quarterly

option expiration dates to the overall

values so basically you know 20 years

four quarterly expirations 80 different

we had a set of 80 different numbers

okay let's take a look and see how much

difference there was if there was any

difference at all between you know

whatever given the size of the moves we

looked at a couple different things here

we looked at overall on moves greater

than 1% and overall

on moves greater than 2% all right first

how many moves overall one day moves are

greater than 1% I was surprised by this

but it's 26% of the moves one week it's

56% of the moves and over two weeks you

know talking about moving 1% it's 70% of

the time so we move around the markets

but for option expiration on the

quarterly basis how often was it a lot

more maybe because we have them every

month now or something I don't no these

are these are quarterly expirations no

no I I get that but maybe because you

know listen when I first started trading

we only had quarterly expirations but

now that we have an expiration basically

daily basically weekly basically you

know monthly maybe they just kind of all

blend in because it doesn't seem like

it's uh I would think I would notice

that kind of number this is very

interesting because it's a little bit it

shows that with one greater than 1% move

you're going to have a much higher

percentage on getting into quarterly

expirations which is by the in two weeks

so let's talk overall 2% moves 2% moves

happen in the market on a daily on on a

one day basis two 7% of the time one

week 29 and 43% of the time over two

weeks 2% just to give you an idea is 100

S&P points that's pretty big yeah and

then when you look at

opx quarterly Opex it goes up yeah it

goes up from 7 to 8 from 29 to 35 and

from 43 to 60 um um so there's

definitely more volatility

around the quarterly expiration cycle

now sure because we also measured this

in with vix you know does the

market adjust for it and because we're

able to do this of course it does yeah

yeah yeah you know like this isn't we're

not showing you something that's not

already priced in just so you know like

there's no there's no edge here this is

just to know that there's a little bit

more volatility coming right around the

corner so now we take a look at all the

overall moves again just like we did

just like we did before but now we look

at it verse overall expected and then

just overall because we didn't look at

just every move combined right we only

looked at plus one% I mean plus one

times and two times and then we see here

which is which is quite interesting is

that when we take all the moves there's

just a incremental difference it's is it

a little bit greater sure does the

difference between 26 and 28 make a

difference nah I mean 27 29 not really

it's not really something that's

necessarily tradable when you look at

overall 2x expected versus overall

versus Opex

expected um the difference is again

statistically insignificant so when you

combine when you take all the numbers

combined and you look at it on an

expected basis or what actually

happened um on the expected basis it's

pretty much spoton which means that

volatility has adjusted right if you if

you go back one slide Beth just for a

second this is this is this is actual

right so when you look at the actual

thing what happened there's a big

difference between the two but when you

go to the next slide this is where we'd

use this is where we use volatility so

no go next slide so this is what the

expected move is remember we measured

adverse volatility so volatility is the

expected move so when you look at it

verse expected move what what the

research team was trying to show you

here is that when you look at expected

move it's correct when you look at it

vers historical moves it's greater than

so all we're saying is the market does a

perfect job of pricing

everything like every time you think oh

I found something where there's some no

it's priced perfectly yeah no I get it

okay yeah sometimes that's kind of hard

for people but that's no no it is kind

of hard it's a great point to make yeah

expected move is what volatility tells

us that's where we measured against the

vix the actual move is what we the first

piece that we did so takeaways in

absolute terms quarterly expirations did

seem to result that was the first slide

did seem to result in more volatile

markets than an average day but when

adjusted for volatility derived expected

moves

the difference largely went away so

while quarterly expirations are an

active time in the market and they can

be good for retail Traders from a

liquidity perspective Market

participants need to be aware of the

additional risk and premiums but they've

been adjusted accordingly because the

market already knows that that's how

smart markets

are it's smarter than the average bear

yes