Vilified Zero-Day Options Blamed By Traders For S&P Decline

(Bloomberg) -- This year’s hottest derivatives trade, and perhaps also its most divisive, stole the limelight one final time for 2023 as market watchers cast zero-day options as the villains behind Wednesday’s rally-ending slump in US equities.

With the S&P 500 Index in overbought territory and turnover curtailed by looming holidays, observers suggested hefty volumes in put options that expire within 24 hours, known as 0DTE options, were sufficient to drag the market to its biggest loss in almost three months. Such trades would oblige market makers on the other side of the transactions to hedge their exposure, pushing the market lower, the argument goes. 

“We have been wary of 0DTE options for quite some time,” Matthew Tym, the head of equity derivatives trading at Cantor Fitzgerald LP, wrote in a note with colleague Paolo Zanello. “Today we saw a late day selloff that, we believe, could have been caused by or certainly exacerbated by 0DTE SPX options. Certainly the market environment was ripe for it.”

It was trades in put options, which give buyers the right but not the obligation to sell an underlying asset, around the 4,755-4,765 area that drew attention, they said. The S&P gauge slid from as high as 4,778.01 intraday to close at 4,698.35. Its 1.5% drop from the previous close was the biggest since Sept. 26. Relative strength readings on the gauge had been hovering at levels typically seen before a decline. Wall Street’s fear gauge — the VIX — rose sharply from near multi-year lows.

Amid an explosion in trading of zero-day contracts for every weekday this year, debate continues to rage on their broader impact. For institutional investors, “zero-day-to-expiry” options offer a way to hedge short-term risk and pursue strategies based on darting in and out of positions. For retail investors, they offer a way to make big bets with little money down that can pay off quickly — or not. 

While the likes of JPMorgan Chase & Co.’s Marko Kolanovic have warned that the popularity of the product risks reprising past shocks such as the 2018 Volmageddon episode, Cboe Global Markets says there’s scant evidence that the buying and selling of the derivatives is destabilizing the underlying market.

Options analysis firm SpotGamma said in a post on social media platform X that 0DTE options drove the decline in the US equity benchmark. Rocky Fishman, founder of derivatives analytical company Asym 500, pointed out that the daily 0DTE volume was the highest since early October — $900 billion — which was noteworthy given the lack of specific economic news during the day. 

“The elevated volumes could have contributed to the selloff if the extra activity was directional option-buying,” Fishman said.

(Updates with comments from Asym 500 and SpotGamma in seventh and eighth paragraphs)

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