In late 2022 (and so far this year), zero-days-to-expiration (0DTE) options have been driving significant moves in the US equity market. Traders have used these options to take advantage of short-term price movements in individual stocks and broad market indices, leading to sharp swings in market prices.
As a result, 0DTE options have come under increased focus and scrutiny among investors and analysts.
What are 0DTE options and how do they work
0DTE options are option contracts that expire the day they are traded, meaning they have zero days to expiration. These options can be bought or sold, allowing traders to profit from short-term price movements in the underlying asset.
A key difference between 0DTE options and traditional options is their risk profile. Because they have such a short lifespan, 0DTE options are high-risk, high-reward investments. They offer traders the potential for significant profits in a short time, or substantial losses if the price of the underlying asset moves against them.
A trader who buys a 0DTE call option has the right to buy the underlying asset at a predetermined strike price until the end of the trading day. If the price of the underlying asset rises above the strike price, the option becomes valuable and the trader can sell it for a profit.
Conversely, a trader who buys a 0DTE put option has the right to sell the underlying asset at a predetermined price until the end of the trading day. If the price of the underlying asset falls below the strike price, the option becomes valuable and the trader can sell it for a profit.
Because 0DTE option pricing may be extremely sensitive to changes in the price of the underlying asset and market circumstances, the value of the option can change quickly, making them more difficult to trade than conventional options.
0DTE options have impacted the broader equity market and individual stocks significantly in the past few years. Accordingly, the number of market participants who employ them in their trading strategies has increased.
A significant role in recent market swings
0DTE options have been driving significant market moves in the US equity market recently. Although they have been available for some time, their popularity soared during the record selling last year—0DTE options offer a low-cost, quick and simple method of daily hedging when previous correlations fail. By the end of 2022, 0DTE options represented more than 40% of the options volume of the S&P 500, nearly doubling over the last six months.
Source: Goldman Sachs Global Investment Research
In such an uncertain economic environment, short-term options have become a popular way to take advantage of short-term price movements in individual stocks and broad market indices. Retail investors have been using these options increasingly, although they still represent a small share of the total options volume—only 5.6% of the S&P 500 short-term options volume in November came from retail market orders.[1] According to JP Morgan, the intraday trading volume of 0DTE options exceeded $1 trillion.
This ramped-up use of 0DTE options has also contributed to increased volatility and heightened trading activity as investors seek to profit from rapid market changes. Marko Kolanović, a strategist at JP Morgan, expressed a highly bearish outlook on the situation, which “could lead to a vicious cycle in which declining market liquidity leads to rapidly falling option prices, which in turn leads to further declines in liquidity."
What does it mean for investors
The recent rise of 0DTE options has significant implications for investors and traders. Below are several important takeaways:
Increased volatility
0DTE options tend to be more volatile than longer-term options, partly because they have a short lifespan. When traders buy and sell these options in large volumes, it can lead to increased volatility in the underlying asset, making the market less predictable and subject to sudden price swings.
Heightened trading activity
Because 0DTE options have a short lifespan, traders must act quickly to capitalize on short-term price movements. This can lead to increased trading activity as traders buy and sell these options in large volumes to take advantage of short-term opportunities.
Impact on individual stocks
0DTE options can have a significant impact on individual stocks, particularly if a large number of traders are buying or selling options related to that stock. For example, if a large number of traders purchase 0DTE call options on a particular stock, the price of the stock could increase as traders try to capitalize on short-term price movements. Similarly, if a large number of traders purchase 0DTE put options on a particular stock, the price of the stock could decrease as traders try to profit from short-term price declines.
Influence on market sentiment
As more traders use 0DTE options to capitalize on short-term price movements, market sentiment could be influenced to shape the broader market narrative. For example, when traders are bullish on a particular stock or market index and are buying 0DTE call options, it can create a positive market sentiment that attracts other investors and traders to buy into the market. Similarly, if traders are bearish on a particular stock or market index and are buying 0DTE put options, it can create a negative market sentiment that may drive other investors and traders away from the market.
Potential for market manipulation
The rise of 0DTE options has also created concerns about potential market manipulation. Some traders may use large volumes of 0DTE options to influence short-term price movements, which can create challenges for other investors trying to make informed decisions based on market fundamentals.
The impact of 0DTE options on the broader equity market and individual stocks can be significant, particularly if a large number of traders use them to capitalize on short-term price movements. While 0DTE options offer potential benefits for traders who are skilled at navigating short-term market volatility, they also come with a range of risks and potential losses if traders cannot predict short-term market movements accurately.
Investors who are considering these options should have a solid understanding of their risk and benefits and should consider their investment goals and trading strategy carefully before trading.
0DTE options in this market environment
0DTE options might continue to drive market moves through the end of 2023 if traders use them to speculate on short-term price movements. Additionally, broader market factors such as macroeconomic conditions, company earnings reports and market sentiment could contribute to those market moves. Many investors rely on those indicators to gauge trends and make investment decisions; but these may not always be accurate and could lead to rash (and unsuccessful) trades.
The short-term outlook for 0DTE options is highly dependent on market conditions and investor sentiment. While they provide traders the opportunity to capitalize on short-term market movements, they come with significant risk. As these options have a short lifespan, they require constant monitoring and quick decision-making to realize potential profits. 0DTE options are also highly sensitive to changes in market liquidity and can be subject to rapid price movements. Overall, the short-term outlook for 0DTE options is uncertain and requires careful consideration of market conditions and individual risk tolerance.
This is where alternative investments come in. Unlike liquid investments that are subject to distortion and manipulation driven by the latest Wall Street fads, the returns of alternative investments are not subject to such distortions and should be in an investor's portfolio. They offer investors a way to diversify their portfolios and reduce their exposure to market volatility.
About The Family Office
The Family Office is a leading private market solutions provider with more than $2 billion of assets under management. With a focus on diversified alternatives, such as private equity, private debt, and real estate, The Family Office provides a comprehensive suite of investment opportunities to meet the unique needs of its clients.
Whether you seek to diversify your portfolio, generate income, or capture growth opportunities, The Family Office has private market solutions that can help you achieve your financial goals. With a commitment to transparency, integrity and personalized service, The Family Office is a trusted partner for investors who seek to build and preserve wealth over the long term.