Exploring the Weekly Options
CME: E-Mini Nasdaq 100 Weekly Options (Q1D-Q5D)
When I first started trading two decades ago, I was overwhelmed by the amount of data that was available. I had a hard time correlating how data relates to price movement. While observing the stock market, I have one question in particular: why does the market often moves drastically immediately after the release of a major report?
Over time, I learnt that these reports provide insight into how the economy works. New data validates our assumptions about the future. Take the United States as an example:
• Consumers drive the U.S. economy;
• Consumers need jobs to be able to buy things and keep the economy going;
• The ebb and flow between the degree of joblessness and full employment drive economic activity up or down;
• How easy or difficult for households and businesses to get credit affects consumption, jobs, and investment.
The following reports have an outsized impact on global financial markets:
• The Nonfarm Payroll Report, released by the Bureau of Labor Statistics (BLS);
• The Consumer Price Index, also published by the BLS;
• Personal Income and Outlays, by the Bureau of Economic Analysis (BEA);
• Gross Domestic Product (GDP), also by the BEA;
• Federal Open Market Committee (FOMC) meeting, this is where the Federal Reserve sets the Fed Funds interest rates, ten times a year;
• Interest rate actions by other central banks, including European Central Bank, the Bank of England, the Bank of Japan, and the People’s Bank of China.
Binary Outcomes: Ideal Setting for Options Trading
For these highly anticipated reports, investors usually reach a consensus on the expected impact of the new data prior to its release. Market price tends to price in such investor expectations.
The next FOMC meeting is on September 20th. According to CME Group’s FedWatch tool, the futures market currently expects a 94% probability that the Fed would keep the Fed Funds rate unchanged at the 5.25%-5.50% range.
The September contract of CME Fed Funds Futures (ZQU3) is last settled at 94.665. This implies a Fed Funds rate of 5.335%, right in the middle of the target range.
When new data is released, investors focus less on the actual data, but more on how it compares to the consensus. Because the prevailing price already reflected market expectation, new data serves to either confirm or dispute it. We could use a range of -1 to +1 to categorize these outcomes:
• Well Below Expectations, -1;
• Meet Expectations, 0;
• Well Above Expectations, +1.
The sign of the outcome does not necessarily correspond to a positive or negative price movement. It differs by the type of data and the respective financial instrument.
We could further simplify the results into binary outcomes:
• Within Expectation: 0, where actual data approximates previous expectation;
• Beyond Expectation: 1, either below or above expectation by a pre-defined margin.
Both human and computer think in binary terms: Light switch On or Off, Price goes Up or Down, Risk turns On or Off. In derivatives market, we could buy a Call Options if we expect the price to go up, and a Put Options if we think the price will decline.
Weekly Options for Event-Driven Strategies
The FOMC meeting is the most significant event that affects global markets. Market may stay calm if the Fed keeps rate unchanged (within expectation). However, if the Fed raises rate unexpectedly, you could hear investors screaming all around the world!
To trade the Fed decision, investors could form different strategies using a wild variety of instruments, such as stock market indexes, Treasury bonds, forex futures, gold, WTI crude oil, and even bitcoin. Today, we focus on the Nasdaq 100 index. Here are some alternatives to consider:
• Nasdaq 100 ETF: many asset managers offer them, including Invesco, iShares and ProShares. From a trader’s perspective, ETFs offer no leverage. A 100K exposure requires 100K upfront investment. If the market moves up 1%, you also gain 1%, minus the fees.
• Nasdaq 100 Futures: CME Micro Nasdaq 100 (MNQ) has a notional value of 2 times the index, valuing it at $31025, given the Nasdaq’s last close at 15512.5. Each contract requires initial margin of $1680. The futures contract is embedded with an 18.5-to-1 leverage.
• Nasdaq 100 Options: As the nearby September contract expires on the 3rd Friday, or the 15th, ahead of the FOMC meeting date, we could not use it for our strategy. Instead, we could apply it with the December contract (NQU3). On September 1st, the 15800-strike Call is quoted $541.50, and the 15400-strike Put is quoted $535.
• Weekly Options: On September 1st, the 15800-strike Call to expire in one week is quoted $14.25, while the 15400-strike Put to expire in one week is quoted $54.50.
Premiums for the standard American-style Options are expensive. They come with quarterly contracts and quarterly expirations. While our target date is September 20th, we have to use the December contract and acquire 3-1/2-month worth of time value.
Weekly options, on the other hand, offer more precise trading and risk management with more expirations. Investors pay low premium to get the exposure they need and avoid the unnecessary and costly time value.
For E-Mini Nasdaq 100, the weekly options that expire on Wednesday, September 20th will be listed on the prior Thursday, September 14th. If an investor forms an opinion about the FOMC decision, he could implement it with a weekly call or put next week.
Nasdaq Weekly Options are deliverable contracts. If an investor owns a call and it expires in the money, he will settle the contract with a long position in E-Mini Nasdaq 100 futures. Likewise, if he owns an in-the-money put, he will get a short futures position.
If the market moves in favor of an investor’s expectation, the potential payoff could be significant due to the leverage in weekly options. If the investor is incorrect, he could lose money, up to the amount of the entire premium. However, the low-premium nature in weekly options helps contain such loss at a tolerable level.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
When I first started trading two decades ago, I was overwhelmed by the amount of data that was available. I had a hard time correlating how data relates to price movement. While observing the stock market, I have one question in particular: why does the market often moves drastically immediately after the release of a major report?
Over time, I learnt that these reports provide insight into how the economy works. New data validates our assumptions about the future. Take the United States as an example:
• Consumers drive the U.S. economy;
• Consumers need jobs to be able to buy things and keep the economy going;
• The ebb and flow between the degree of joblessness and full employment drive economic activity up or down;
• How easy or difficult for households and businesses to get credit affects consumption, jobs, and investment.
The following reports have an outsized impact on global financial markets:
• The Nonfarm Payroll Report, released by the Bureau of Labor Statistics (BLS);
• The Consumer Price Index, also published by the BLS;
• Personal Income and Outlays, by the Bureau of Economic Analysis (BEA);
• Gross Domestic Product (GDP), also by the BEA;
• Federal Open Market Committee (FOMC) meeting, this is where the Federal Reserve sets the Fed Funds interest rates, ten times a year;
• Interest rate actions by other central banks, including European Central Bank, the Bank of England, the Bank of Japan, and the People’s Bank of China.
Binary Outcomes: Ideal Setting for Options Trading
For these highly anticipated reports, investors usually reach a consensus on the expected impact of the new data prior to its release. Market price tends to price in such investor expectations.
The next FOMC meeting is on September 20th. According to CME Group’s FedWatch tool, the futures market currently expects a 94% probability that the Fed would keep the Fed Funds rate unchanged at the 5.25%-5.50% range.
The September contract of CME Fed Funds Futures (ZQU3) is last settled at 94.665. This implies a Fed Funds rate of 5.335%, right in the middle of the target range.
When new data is released, investors focus less on the actual data, but more on how it compares to the consensus. Because the prevailing price already reflected market expectation, new data serves to either confirm or dispute it. We could use a range of -1 to +1 to categorize these outcomes:
• Well Below Expectations, -1;
• Meet Expectations, 0;
• Well Above Expectations, +1.
The sign of the outcome does not necessarily correspond to a positive or negative price movement. It differs by the type of data and the respective financial instrument.
We could further simplify the results into binary outcomes:
• Within Expectation: 0, where actual data approximates previous expectation;
• Beyond Expectation: 1, either below or above expectation by a pre-defined margin.
Both human and computer think in binary terms: Light switch On or Off, Price goes Up or Down, Risk turns On or Off. In derivatives market, we could buy a Call Options if we expect the price to go up, and a Put Options if we think the price will decline.
Weekly Options for Event-Driven Strategies
The FOMC meeting is the most significant event that affects global markets. Market may stay calm if the Fed keeps rate unchanged (within expectation). However, if the Fed raises rate unexpectedly, you could hear investors screaming all around the world!
To trade the Fed decision, investors could form different strategies using a wild variety of instruments, such as stock market indexes, Treasury bonds, forex futures, gold, WTI crude oil, and even bitcoin. Today, we focus on the Nasdaq 100 index. Here are some alternatives to consider:
• Nasdaq 100 ETF: many asset managers offer them, including Invesco, iShares and ProShares. From a trader’s perspective, ETFs offer no leverage. A 100K exposure requires 100K upfront investment. If the market moves up 1%, you also gain 1%, minus the fees.
• Nasdaq 100 Futures: CME Micro Nasdaq 100 (MNQ) has a notional value of 2 times the index, valuing it at $31025, given the Nasdaq’s last close at 15512.5. Each contract requires initial margin of $1680. The futures contract is embedded with an 18.5-to-1 leverage.
• Nasdaq 100 Options: As the nearby September contract expires on the 3rd Friday, or the 15th, ahead of the FOMC meeting date, we could not use it for our strategy. Instead, we could apply it with the December contract (NQU3). On September 1st, the 15800-strike Call is quoted $541.50, and the 15400-strike Put is quoted $535.
• Weekly Options: On September 1st, the 15800-strike Call to expire in one week is quoted $14.25, while the 15400-strike Put to expire in one week is quoted $54.50.
Premiums for the standard American-style Options are expensive. They come with quarterly contracts and quarterly expirations. While our target date is September 20th, we have to use the December contract and acquire 3-1/2-month worth of time value.
Weekly options, on the other hand, offer more precise trading and risk management with more expirations. Investors pay low premium to get the exposure they need and avoid the unnecessary and costly time value.
For E-Mini Nasdaq 100, the weekly options that expire on Wednesday, September 20th will be listed on the prior Thursday, September 14th. If an investor forms an opinion about the FOMC decision, he could implement it with a weekly call or put next week.
Nasdaq Weekly Options are deliverable contracts. If an investor owns a call and it expires in the money, he will settle the contract with a long position in E-Mini Nasdaq 100 futures. Likewise, if he owns an in-the-money put, he will get a short futures position.
If the market moves in favor of an investor’s expectation, the potential payoff could be significant due to the leverage in weekly options. If the investor is incorrect, he could lose money, up to the amount of the entire premium. However, the low-premium nature in weekly options helps contain such loss at a tolerable level.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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