The Underappreciated Role of Zero-Dated Options in the Current Rally

As we noted last week, it was a year ago that so-called “zero-dated” or “0DTE” options became a talking point.  Their role in elevating the market from that time forward is underappreciated.  Rather than being a trigger for a potential “Volmaggedon,” they have been a more consistent force behind the bull market.  In the past year we’ve seen numerous days when modest rallies turned into big moves seemingly out of nowhere – and more often than not, those rallies have stuck.  Those rallies have often been turbocharged by 0DTE options. 

It is important to remember the history behind 0DTE.  Bear in mind that we’ve always had options with zero days to expiration because every option eventually has zero-days to expiration.  The difference is that those only occurred on monthly, and later, on weekly expiration dates.  Over time, as more options had weekly expirations (over 600 now), that reduced the emphasis on “triple witching”.

Bear in mind that no one paid much attention when Monday and Wednesday expirations in key indices and ETFs arrived in 2016 and few cared when Tuesday and Thursday expirations arrived in 2022.  So why did they only become “a thing” during a bull run in early 2023.  Why?  Remember, 2022 was a bear market.  By 2023 we’d begun to turn around.  Most speculators tend to be more comfortable trading from the long side than the short side.  Volumes tend to decline in bear markets.  That implies that casual traders step back during downturns.[i]

Thus, when traders sought a tool to profit from the rally that ensued after the FOMC meeting on February 1^st, 2023 that would not leave them exposed to the jobs report two days later, the first bull market use case of 0DTE options arose.  After record volumes and big moves on those days – the S&P 500 (SPX) rallied +1.05% on the 1^st, another +1.47% on the 2^nd, and fell -1.04% on the 3^rd — market observers took note of the heavy options volume that surrounded the moves and noticed the role of 0DTE options in them.

Options speculators may have taken a breather through much of 2022, but they didn’t disappear.  Many individuals discovered options en masse during Covid, coming to options because of their similarity to sports betting during a time when professional sports largely went dark.  I first wrote about this in September 2020.

In both cases, the options buyer or sports bettor lays out a fixed amount of cash in hopes of a leveraged payout.  But those new speculators realized that there were key advantages in options trading.  Markets offer more contests to bet on; bid/ask spreads and commissions on options trading are much lower than gambling odds; and most importantly, options traders can influence the outcome of the game in a way that sports bettors can’t! 

If enough gamblers bet on, say, the Chiefs in tomorrow’s Super Bowl, it will move the odds but have no influence on the outcome of the game.  However, if enough traders buy calls on SPY or SPX, that can indeed move the market higher.[ii]

Thus, the tactics used in0DTE trading had their roots in weekly options activity on Fridays.  By April 2021 I was writing that it had become somewhat routine for markets to have mysterious rallies on Fridays.  That was the effect of traders buying expiring weekly calls.  (Remember, every option is 0DTE on expiration day!) We noted the following on February 9^th, 2023:

last year, we saw exchanges list so-called “zero-dated” or “0DTE” options listed in a range of key indices and ETFs.  They have proven immensely popular, with cumulative options volume setting a record last Thursday (the day after the FOMC meeting).  For better or worse, they have made speculation incredibly easy.  It is likely that these products exacerbated December’s decline, and it is almost certain that they have accelerated this year’s rally.  Most traders are more comfortable trading from the long side rather than the short side, which explains the recent pops in volume on up days. 

… it would not be surprising if these ultra-short-term options lead to microbursts of volatility and the occasional spurious move.

And last week we wrote:

I would assert that these options continued to accelerate the rally that began in January 2023.  I also firmly believe that we have seen no shortage of “microbursts of volatility.”  Yesterday’s rally was one of them.  It is understandable why traders might have sought to buy the dip after Wednesday’s post-FOMC swoon, but it is quite clear that the move higher was turbocharged by 0DTE options.  Over 500,000 expiring calls traded in the SPX index options alone, not to mention thousands more in similar products like SPY and QQQ.  It’s hard to imagine that traders would have been so eager to continually press their bullish bets into the close if they needed to be concerned with carrying positions into a jobs report.

Now, think about some of the rallies that we have seen come seemingly out of nowhere.  Many of them have the same characteristics, but they are no longer limited to Fridays.  We see hordes of buyers of the slightly out of the money SPX calls that have become the preferred tool of 0DTE trades, then as the index rises from the weight of that buying, those options get rolled into the next higher strike, and if the rally really gets rolling, the buyers can do it multiple times (aka, rinse and repeat).

It is important to remember that although I have mentioned the role of individual speculators, 0DTE buying is by no means limited to them.  Institutions have joined the fray.  And when money is flowing into markets, as it clearly is now, there is a ratcheting effect to even spurious rallies.  In highly trending, momentum-driven moves, they are more likely to be the starting point for tomorrow’s buying rather than a spot where contrarians seek opportunities to sell.  As a result, the various intraday rallies that have been abetted, if not initiated, by 0DTE speculation have indeed had a meaningful impact on the past year’s move higher.

—

[i] Here is a sports analogy – decent basketball players can make a layup with their dominant hand, but pros can use either hand equally well.

[ii] Ask yourself if you’d ever heard the term “gamma squeeze” prior to Covid.  I highly doubt anyone who wasn’t a professional options traders had.