Momentum in the Option Market, Part 3

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In previous posts, we discussed the momentum phenomena in the options market. In essence, evidence suggests that delta-hedged straddle option positions exhibit momentum. This means that firms whose options performed well in the past 6 to 36 months are likely to experience high option returns in the next month.

Reference [1] expanded this momentum analysis to the constituent firms of the S&P100 index. The authors pointed out,

We observe significant momentum returns in both straddle and strangle strategies. Firms whose options demonstrate robust performance over the preceding periods of 2 to 12 months, 2 to 24 months, and 2 to 36 months are more likely to experience heightened option returns in the subsequent month. Notably, among these, the momentum effect associated with a 2 to 24-month formation period yields the highest return with the most significant level when compared to other formation periods. This result is consistent for both straddle and strangle strategies.

In brief, momentum in delta-neutral straddles and strangles is strongly present among the constituent firms of the S&P 100 index. Interestingly, the authors pointed out that this momentum doesn’t exist in butterfly positions. However, the cause of this phenomenon is still unknown.

Conversely, options strategies like butterfly spreads, betting on lower volatility in the underlying stocks and coupling with a capped payoff in the event of volatility shocks, are less likely to have momentum effects. This observation provides valuable implications for the relationship between options strategy characteristics and their propensity to generate momentum effects.

Butterfly spreads are widely used in options trading, yet they don’t demonstrate momentum. What does this mean for traders?

Let us know what you think in the comments below or in the discussion forum.

References

[1] Wei, Peng and Cao, Yi and Dong, Yizhe, Option Momentum: Further Evidence. https://ssrn.com/abstract=4657193

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

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