Case study of event risk management with options strangles and straddles

Abstract

Event risk environments may involve an elevated probability of both volatility regime shifts and sharp, abrupt price changes, either up or down. Purely direction‐oriented risk management approaches are not necessarily well‐suited for these market conditions. In this exploratory case study, we look at the possibility that non‐directional options strategies, such as straddles and strangles, may offer interesting benefits in the management of potential event risk environments. Our research involves only the case of the S&P500® Index from 2018 through 2020. We utilize the Market Sentiment Meter from CME Group to identify periods in which event risk may be present and particularly when the probability of sharp, abrupt price changes may be elevated. Our findings in this specific case suggest that selling option straddles and strangles during typical market conditions and then buying option straddles and strangles when the market sentiment switches to a more extreme state offers potential as an effective risk management approach for event risk. More research is needed over longer periods and for different securities, including international equity indices, to explore the usefulness of options strategies for event risk management.

Trading Time Seasonality in Commodity Futures: An Opportunity for Arbitrage in the Natural Gas and Crude Oil Markets?

“…Journal Pre-proof are likely to go down or up and have been investigated in the past for their potential use as sentiment indicators, see for example Pan and Poteshman (2006) and Bathia and Bredin (2013). More recently put-call ratios have even gained more prominence by being included in a key sentiment indicator, the so called Market Sentiment Meter published by the CME Group, see Kownatzki et al (2022) and Putnam (2020) for details. Considering someone who is buying a put as a short hedger and someone buying a call as a long hedger the put-call ratio can also be used as a proxy for hedging pressure.…”