Wall Street's Zero-Day Options Frenzy Continues: Is It a Ticking Time Bomb?
As Wall Street's infatuation with rapid-fire stock options approaches its two-year mark, a Bloomberg Markets Live Pulse survey indicates the trend's momentum may not be waning, even though concerns of an eventual market crash loom among industry participants.
April's data showed that zero-days-to-expiration (0DTE) contracts linked to the $S&P 500 Index(.SPX.US$ soared to an estimated $862 billion in notional value. Surprisingly, nearly 90% of the 300 respondents in the MLIV Pulse survey anticipate this growth will persist. The catch, however, is that sentiment is nearly divided down the middle on whether this will lead to stable expansion or result in a disastrous ending.
0DTE equity derivatives, characterized by their sub-24-hour lifespans, have become a staple for traders of all sizes as they attempt to steer through economic uncertainty and the unpredictable policies of central banks. In the previous year, 0DTE represented 45% of the S&P 500 options market volume—double the amount prior to their broad accessibility in Q2 2022.
Phil Pecsok, Chief Investment Officer at Anacapa Advisors, notes, "Exchanges are profiting tremendously from permitting daily options trading. As evident, volumes have increased as the investment tool becomes more accessible to a wider audience. Their prevalence is only set to grow."
The magnitude of this boom, however, has sparked debate. Concerns are mounting that the flurry of activity in ultra-short-dated options may be influencing stock market volatility. Moreover, studies have indicated that retail investors frequently incur losses when dabbling in these options.
The majority of survey respondents acknowledged this risk, with 56% suggesting that it's all too easy to lose money with these financial instruments. Nevertheless, there was little appetite for restricting retail access to 0DTE. A solid 76% of those surveyed—almost two-thirds of whom are professional investors—argue that easy accessibility is fair play.
"If there is a big move when these options get in the money, and sellers cannot support these positions, forced covering would result in very large directional flows. These flows could particularly impact markets given the current low liquidity environment," according to JPMorgan's Marko Kolanovic.
Expanding use of 0DTE while potentially diluting concerns that its proliferation threatens market stability could risk reprising past disasters such as the 2018 Volmageddon episode, which led to a rapid sell-off in the stock market and the implosion of products betting against volatility, causing significant losses for investors. $Cboe Global Markets(CBOE.US$, the exchange at the center of the trading boom, argues that as trading flows spread out, the peril of a one-sided market is lessened.
Cboe says the diverse applications for 0DTE preclude the formation of crowded one-way bets that could render the market vulnerable to abrupt shocks. About two years ago, Cboe broadened the expiration schedule for S&P 500 options to encompass every market day, and subsequently did the same for Russell 2000 options as well.
The MLIV survey revealed a split in opinion regarding the repercussions of 0DTE on foundational markets. A quarter of those surveyed expressed significant concern, while 41% were moderately worried. However, 34% of respondents weren't worried at all.
Still, when prompted to characterize 0DTE, the commentary from MLIV Pulse contributors — predominantly from the U.S. and Europe — was often critical.
Common descriptors included "gambling," "a slot machine in Vegas," and "atom bombs." Others described 0DTE options as mechanisms that facilitate a wealth shift from naive retail and institutional investors to exchanges and market makers.
On the flip side, advocates emphasized the utility of 0DTE as hedging tools, with one participant describing them as "a relatively inexpensive method for investors to bet on a stock's directional move without holding the actual shares."
The MLIV Pulse survey, conducted among Bloomberg terminal and online readers by the Markets Live team, often covers a range of financial topics.
Lately, major banks like $Citigroup(C.US$, $JPMorgan(JPM.US$, and $UBS Group(UBS.US$ have embraced the burgeoning trend of zero-days-to-expiration (0DTE) derivative contracts, with their quantitative investment strategies (QIS) teams integrating these options into new and existing trades for clients. These strategies, which include low-cost bets on volatility and portfolio diversification, have gained traction due to a "virtuous cycle" of liquidity that 0DTEs can offer.
Michele Cancelli, Citi's global head of QIS trading and structuring, believes that the advantages in terms of risk management are clear, particularly the minimized overnight market move risks. By incorporating 0DTEs, banks can offer products that provide similar returns to traditional volatility bets -- but with reduced risks and volatility, reflecting Wall Street's ability to rapidly develop products in response to market changes.
Source: Bloomberg, WSJ
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