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Trading Around Option Expiration Days

Posted in Calendar Effects, Equity Options

Are there any stock market return/volatility anomalies around the equity option expiration (OE) day (third Friday of each month)? Potential anomalies include: (1) systematic differences in returns and volatilities before, on and after OE; and, (2) systematic differences in OE returns conditional on prior-month returns. To investigate, we examine close-to-close returns from five trading days before through five trading days after OE. Using daily closing prices for the S&P 500 Index for January 1990 through December 2013 (287 OEs, with September 2001 excluded due to trading disruption) and for the iPath S&P 500 VIX Short-Term Futures ETN (VXX) during January 2009 through December 2013 (59 OEs), we find that:

The following chart shows average daily S&P 500 Index returns from five trading days before (OE-5) through five trading days after OE (OE+5) over the available sample period, with one standard deviation variability ranges. The mean daily return for all trading days in the sample is 0.03%. Results suggest a modest positive bias for a few days before and a negative bias just after OE. However, variability swamps average returns.

Is there a consistent pattern across subperiods?

SP500-returns-around-OE

The next chart summarizes average daily S&P 500 Index returns from OE-5 through OE+5 for three equal seven-year subperiods and since the beginning of 2011 relative to mean returns for respective subperiods (raw average daily return minus average return for all trading days in the subperiod). The number of observations for the first three subperiods is 83-84, with only 36 observations in the last subperiod. While results loosely support belief in relative strength before and relative weakness after OE, inconsistencies undermine confidence.

Does OE return depend on market return since the prior OE?

The following scatter plot relates return on OE to return from the close on the preceding OE through the day before OE. For example, if two successive OE days are 5/15 and 6/19, the chart relates the return on 6/19 to the return during 5/15-6/18. The Pearson correlation between the two series is 0.02 and the R-squared statistic is 0.000, indicating no relationship. In other words, aggregate investor behavior is indifferent to prior-month return. Perhaps dynamic hedging obviates any OE day price pressure.

Does OE return depend on whether the stock market is in a bull or bear state?

SP500-returns-on-OE-based-on-prior-return

The next chart summarizes average daily S&P 500 Index returns from OE-5 through OE+5 during bull and bear states, determined by whether the index is above or below its 200-day simple moving average at the close on the day before OE. The number of bull (bear) observations is 206 (81). Average returns are notably lower during the bear state during the two days just before and just after OE.

Does VXX exhibit a return pattern around OE?

SP500-returns-around-OE-bull-bear

The final two charts show average daily VXX returns from OE-5 through OE+5. The upper chart covers the entire available sample period, with one standard deviation variability ranges. The lower chart shows average returns only for bull and bear market states as defined above. The number of bull (bear) observations is only 46 (13). The mean daily return for VXX over all trading days in the sample is -0.34%.

The upper chart suggests that VXX tends to be relatively strong just before OE and relatively weak after OE. The lower chart indicates that pre-OE strength comes from bear markets only. The most consistent indication is to short VXX for a few days after OE. However, given the variability of returns, the available sample is small for inference (a few new observations could materially alter results).

VXX-returns-around-OE

VXX-returns-around-OE-bull-bear

In summary, evidence from simple tests on available data offers slight support for belief in a modest positive (negative) bias for the broad stock market and near-term volatility futures a few days before (after) equity option expiration dates.

Cautions regarding findings include:

  • The subsample for the S&P 500 Index since the beginning of 2011 is short for useful inference.
  • As noted, VXX returns exhibit strong variability, making the entire sample for VXX short for reliable inference.
  • Trading frictions incurred in attempting to exploit any anomalies would reduce reported returns.
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