A long-held dream for traders was consequence-free speculation, something that allowed them to take big positions with neither overnight risk nor the potential costs of exiting a day trade. It was exactly one year ago today when a multitude of traders discovered that so-called “zero-dated”, or “0DTE” options offered that possibility.
Just as occurred this week, there was an FOMC meeting on a Wednesday ahead of Friday Payrolls report during the first week of February. The exact dates were February 1st and 3rd, 2023. Unlike the most recent meeting, traders were enamored of Chairman Powell’s press conference, and stocks took another leg higher each time he uttered the word “disinflation.” As we wrote on February 8th, 2023:
One week ago, we learned that “disinflation” was the market’s secret word for the FOMC. If you recall, during the early part of Chair Powell’s press conference we saw stocks and bonds both trade lower. The declines ended when the Chairman utilized the term “disinflation.” He then proceeded to use some form of that word – either as a noun or the adjective “disinflationary” – a total of 11 times. Even the thickest of minds can figure out that if something is said 11 times in a relatively short period of time, it must be meaningful. So began a rally that lasted for the rest of the day last Wednesday and Thursday…
In prior years, any trader who wanted to speculate on a Thursday rally ahead of a key payrolls report had a problem. He could use options that expired at Friday’s close, but that would require either selling the position ahead of Thursday’s close or carrying the positions over a potentially market moving economic report. But in May 2022, options on major indices and key ETFs began listing Thursday expirations. As we noted on February 16th, 2023:
…for those who hadn’t noticed, we’ve had sub-weekly expirations for years. The Cboe listed Wednesday-expiring SPX options in February 2016 and Monday expiries in August of that year without much hue and cry. The exchange added Tuesday and Thursday expirations in April and May of last year, similarly with little concern or fanfare.
Quite frankly, there hadn’t been a great use case for these ultra-short-term options. The events of last February gave traders a perfect reason to utilize 0DTE options, and they gravitated to them with a vengeance. After closing 1.05% higher on that Wednesday, the S&P 500 (SPX) rallied an additional 1.47% on Thursday. Options volumes exploded to a record on that Thursday session, propelled largely by traders’ newfound love of 0DTE options. And that love was requited when SPX fell over 1% on the 3rd, as a result of a hotter jobs report.
Those events brought 0DTE options into the forefront of market consciousness. I first wrote about them as part of a broader market piece on February 9th, saying:
How has the plethora of short-term options affected the recent market action? Late 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 tha.”t 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. Over time, the effect will fade. Markets learn to adapt to new financial innovations and speculators can be fickle. But in the short-term, it would not be surprising if these ultra-short-term options lead to microbursts of volatility and the occasional spurious move.
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. (The post-earnings 20% rally in META and 8% move in AMZN were hardly a foregone conclusion, even if they did overwhelm the negative effects of much higher Nonfarm Payrolls and Monthly Average Earnings reports on fixed income markets.)
We never succumbed to the fearmongering that accompanied the early discussions that surrounded last February’s 0DTE frenzy. On February 16th, our piece was entitled, “The Games Haven’t Changed, The Casino Opened More Tables,” noting that 0DTE options fit into a long-established clearing and risk management framework. We followed with a piece for the February 23rd edition of Barron’s entitled, “Zero-Dated Options Are Hot—but Not Hazardous.” There are plenty of reasons to treat ultra-short-term options with a healthy degree of respect, but systemic risk isn’t necessarily one of them.
It is clear that 0DTE options are helping propel equity markets on their year-long rally. We’ve yet to see how they might contribute if the broader sentiment turns. But it is clear that traders love them, and they have certainly changed the market’s climate in a short period of time.
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