Intraday Index Predictability and Options Trading Profitability

Abstract

In this paper we study the intraday dynamics of E-mini S&P 500 index futures and the option trading strategies employing the weekly E-mini S&P 500 index futures options. We make a number of contributions to the literature in the area of intra-day equity index futures return predictability and trading profitability. As far as we know till at present, ours is one of the first studies on intraday implied moments of S&P 500 index futures return using intraday option prices. We use intra-day E-mini S&P500 European-style weekly options data from August 2009 to December 2012 and improve on existing techniques to extract the first four moments of the risk-neutral futures return distribution. Secondly we perform intraday out-of-sample forecasting or prediction, and document the intraday dynamics of the risk-neutral moments. We introduce a novel local autoregression method that allows variable windows in estimating the autoregressive parameters. This is particularly useful in situations when there may be intraday news that cause structural breaks in the otherwise smooth process. It also distinguishes itself from the conventional autoregressive model with predetermined sample lengths. Thirdly, we show profitability in the options trading strategies involving the various risk-neutral moment forecasts, particularly that involving skewness. The positive profitability after transaction costs in skewness trading indicates that the market is not as efficient as thought to be. We also use a novel technique in kurtosis trading that resulted in positive profits before cost, something new in the literature where negative profits were found in kurtosis trading. These results may explain the persistence of intraday trading activities in the market. Our intraday risk-neutral moments also suggest that forecast increases in volatility and skewness lead to an average increase in subsequent return over the next 10 minutes. On the other hand, intraday forecast increase in risk-neutral kurtosis leads to an average decrease in subsequent return. These intraday results appear to be contrary to existing studies using risk-neutral moments over daily intervals. This suggests that intraday price dynamics is different from daily price dynamics.