Zero day to expiry options on the S&P 500 have seen significant growth in volume, accounting for 40-45% of total S&P options volume.
Contrary to misconceptions, there is a balanced positioning in zero DTE options, with customers opening twice as many long positions as short positions and closing out a significant portion of their positions intraday.
Zero DTE options contain a robust volatility risk premium, and selling vertical spreads in iron condor format shows potential for risk-limited income generation.
Deep dives
Zero DTE options make up a significant portion of S&P options volume
Zero day to expiry (DTE) options on the S&P 500 (SPX) have seen a rapid growth in volume, accounting for 40-45% of total S&P options volume. On average, 1.2 million contracts of zero DTE options are traded per day. The market is split roughly 50/50 between market makers and customers, with market makers providing liquidity electronically. The volume and market share of zero DTE options have significantly increased over time.
Misconceptions regarding the imbalance of zero DTE options
Contrary to some misconceptions, the data indicates that there is not a significant one-sided imbalance in zero DTE options. The positioning in these options appears to be well balanced, with customers opening roughly twice as many long positions as short positions. The data also shows that customers tend to close out a significant portion of their positions intraday. While there are differences in how this data is analyzed, the overall conclusion is that the market is not overrun by buyers or sellers.
Volatility risk premium exists in zero DTE options
The volatility risk premium in zero DTE options is a subject of ongoing analysis. It is challenging to measure due to various factors, including calendar and business day annualization conventions and the specific method used to classify trades. However, the data suggests that there is a robust volatility risk premium embedded in zero DTE options. Selling vertical spreads in iron condor format has historically shown potential for risk-limited income generation, but further investigation is needed to fully understand the alpha embedded in selling zero DTE options.
Risks and future research in analyzing zero DTE options
Future research should focus on assessing the risks associated with zero DTE options. The potential risk scenarios include a significant shift in positioning, panic selling or buying of equities intraday driven by the perception of zero DTE options moving the market, and the impact of imbalances on market maker positioning. Understanding the likelihood and potential implications of these scenarios will help in evaluating the overall risks and dynamics of zero DTE options.
Clients' interest in the debt ceiling resolution
There is significant interest among clients regarding the debt ceiling resolution. While the market currently remains calm, there is a cautious approach to potential downside risk hedging. However, there is also increased interest in discussing upside hedges and participating in potential rallies upon a debt ceiling resolution. Clients are exploring the possibility of catch-up rallies in cyclicals and stocks that have lagged during this period.
There's always a bull market somewhere, and in today's climate of hyper short termism, both volume and commentary are thriving in the land of zero days to expiry options. While the risk characteristics of ODTEs are generally agreed on, the directionality of the flows and resulting positioning remain subjects of vigorous debate. With this in mind, it was a pleasure to welcome Nitin Saksena, the Head of US Equity Derivatives Research at BofA Securities, to the Alpha Exchange.
Before embarking on the work that Nitin and team are doing to better understand these ultra short dated options, we survey the landscape of cross-asset vol. Here, Nitin notes that options on certain currency pairs - for example in the Canadian dollar - score on the cheap side on a nominal basis. On a relative basis, rate vol remains substantially high compared to SPX vol as the MOVE index is just 20% off its Covid high while the VIX has declined by 80%.
Next, we turn to the risk implications of the substantial flows in daily SPX options. Given the convexity, there are scenarios imagined by some in the industry in which an unwind of wrong-way exposure can accelerate price movements in the index. While respecting the logic of the analysis, Nitin pushes back on the degree to which the flows are one-way, seeing a balance of trades on the long and short side of options. Still, he cautions that because these instruments and the resulting risk exposures are new, we should be carefully monitoring them. I hope you enjoy this episode of the Alpha Exchange, my conversation with Nitin Saksena.
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