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Zero-Day Options Boom Will Only Grow Even As Some Investors Fear Disaster

In World
May 06, 2024

(Bloomberg) — Two years after Wall Street’s love affair with fast-twitch stock options began, Bloomberg’s latest Markets Live Pulse survey suggests the unprecedented boom still has room to run — even as almost half of respondents fear an eventual blowup.

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With the notional value of zero-days-to-expiration contracts tied to the S&P 500 hitting roughly $862 billion in April, almost 90% of 300 MLIV Pulse respondents said they expect the growth to continue. The twist? They’re about evenly split on whether it will grow steadily or end in calamity.

Equity derivatives with less than 24 hours to expiration, known as 0DTE, have become one of Wall Street’s most popular trades as investors big and small seek to navigate uncertainty over the economy and central bank policy. Trading in 0DTE made up 45% of the total options volume for the S&P 500 last year, about double the level from before the products became widely available in the second quarter of 2022.

“The exchanges are making money hand over fist by allowing daily options. As you’ve seen, the volume has gone up because more and more people have access to it,” said Phil Pecsok, chief investment officer of Anacapa Advisors. “They’re only going to become more prevalent.”

The scale of the boom has stirred controversy. There are concerns the activity in ultra-short-dated options may be affecting stock volatility, while research has suggested that retail investors using them mostly lose money.

A majority of survey contributors showed awareness of the latter risk, with 56% expressing the view that it’s too easy to lose money with the tools. But the concerns didn’t extend to limiting retail access to 0DTE, with 76% of respondents — almost two thirds of whom are professional investors — saying it was only fair to keep them easily available.

Initially picked up by high-frequency traders to make wagers or hedge positions, zero-day options are gaining traction among sophisticated quant pros and small-fry investors alike. They have also found their way to the exchange-traded funds arena.

Both academic and Wall Street researchers have flagged potential dangers with this wave of trading, including that it may make the market more volatile on an intraday basis. JPMorgan Chase & Co. strategist Marko Kolanovic has warned their popularity risks reprising past disasters such as the 2018 Volmageddon episode, a famous blowup that shattered a lengthy calm in US stocks. The theory is that a big stock move could force options dealers, who take the other side of trades and must buy and sell shares to keep a market-neutral stance, to unwind a large amount of their own positions, accelerating any selloff.

The exchange at the center of the boom, Cboe Global Markets Inc., has argued that the wide range of use cases for 0DTE means the trades aren’t creating the kind of crowded one-way bet that might make the market vulnerable to shocks. Cboe expanded expirations of S&P 500 options to every work day about two years ago and later also allowed zero-day options for the Russell 2000 Index.

In the latest expansion, Nasdaq Inc. said it plans more short-term options on commodities and Treasury ETFs.

Opinions about the impact of 0DTE on the underlying market were fairly evenly split in the MLIV survey. Only around a quarter of respondents said they worried a lot about it, with 34% not worried and 41% only a bit worried.

Asked how they would describe 0DTE, the MLIV Pulse contributors — who are predominantly in the US or Europe — were often scathing. “Gambling” was the most common phrase offered. A “slot machine in Vegas,” “atom bombs,” and “tools resulting in a wealth transfer from retail and unsophisticated institutions to exchanges and market makers,” were among the negative descriptions.

The positive contributors largely focused on their usefulness as a hedging tool. As one participant said: “It is a fairly inexpensive way for investors to take a position in the directional move of a stock without having to own the underlying shares.”

So far, 0DTE are available only for major indexes and exchange-traded funds. Their popularity has fueled speculation that zero-day contracts could be broadened to cover single stocks. Asked about that potential expansion, survey respondents were perfectly divided.

The MLIV Pulse survey is conducted among Bloomberg readers on the terminal and online by Bloomberg’s Markets Live team, which also runs the MLIV blog. This week, the survey asks if Bitcoin or large cap US tech stocks offer a safe haven. Share your views here.

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