Thursday Shopping List

Capitalizing on the NFP effect

Jay Powell, a master of communication, kept his cards close to his chest during his appearance before Congress yesterday. He reiterated the Fed's dual mandate: maintaining inflation below 2% while fostering full employment. Powell hinted that rates have reached their peak and that the Fed would consider cutting them if the data supports such a move. As he prepares to address the Senate today, he is expected to deliver a similar message.

Our recent poll, conducted last Sunday, indicates that most of you are in agreement with Powell's stance. The market's reaction further suggests that investors are aligned with the Fed's outlook.

All seems well in the world, but attention has now shifted to the upcoming employment report, with new data set to be released this Friday. This creates an intriguing context for our Thursday shopping list, leading some to question whether proceeding just before such a potentially market-moving event makes sense.

The answer is a resounding yes, now more than ever. The market is fully aware of the impending report and will factor it into the prices accordingly. Choosing not to trade is essentially saying that we believe the market hasn't accurately priced in the NFP figure and that the report will cause significant market disruption.

The possibility of the market mispricing the NFP figure is real, but it's no greater than in any other circumstance. Selling a straddle has an approximately 60% chance of success overall, regardless of whether it's an NFP week or not.

As a data-driven publication, we can support our claims with evidence. We've analyzed the performance of a 1DTE straddle sold on the Thursday prior to NFPs and closed on the following Friday night since 2022 for SPY, IWM, QQQ, and VXX. But first, let's examine the results for a typical Thursday.

Below is a chart illustrating the accuracy of SPY, IWM, QQQ, TLT, and VXX straddles on any given Thursday.

In line with the theory, selling straddles on Thursday wins 60% of the time.

The results closely align with the theory, and we can observe that in the past two years, this systematic strategy has faced challenges in QQQ and SPY.

Selling every 1DTE on Thursday has been challenging in US equities.

In contrast, here are the results for a Thursday prior to NFPs:

The straddle wins almost 65% of the time before NFPs.

The 65% win rate demonstrates that the market is far from naive and efficiently accounts for the NFP risk. In fact, this strategy performs better, on average, than on any other Thursday.

The performance on 1DTE prior to NFPs shows the market’s tendency to overestimate the move on Friday.

All the equity straddles tend to perform well on average, while VXX sees an increase from 22% to 33%.

Could this time be different? Absolutely. That's why it's crucial to keep your risk in check. Ultimately, this strategy performs better on average, proving that the markets do factor in the NFP eventuality in their quotes. However, it's important to note that it doesn't always guarantee a win. Another way to manage your risk is to identify where the NFP effect will be most pronounced and focus on those instances. That is the object of today’s list - let’s dive in.

The rules

Before we start, let’s do a quick round-up about the rules.

• Short an ATM straddle in the 1DTE contract 01/03 as close as possible to the close on Thursday night. In all our metrics and charts, we assumed an execution at 3.50 pm, but the timing of entry doesn’t matter too much: avoid getting in too early, but getting in too late gets you less premium.

• Exit the position as close as possible to Friday's expiration. Again, we assume an execution at 3:50 p.m., but it can be useful to manage the position earlier, depending on your risk tolerance and how happy you are with the returns.

• One word of caution: if you get assigned, get out of the trade completely. Get rid of the underlying. If you decide to keep it and “sell premium against it,” it is at your own discretion and outside this strategy's scope. It’s okay to keep the other leg expiring out of the money; there is no reason to pay an extra dime to your broker.

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