Zero-Day-to-Expiry (0DTE) options have surged in popularity as of late, now exceeding 40% of daily trading volumes in S&P 500-linked options. However, these same-day options have prompted debate amongst capital markets participants.
Numerix participated in a webinar with Risk.net to walk through this controversial topic: Zero-day Options: Ticking Time Bomb or High Alpha Trade? A panel of experts, including Russell Goyder, Fixed Income Product Development at Numerix, shared their views on how and if firms should be using 0DTE options in their portfolios.
Why are ODTE options appealing?
0DTE options can be a fairly low cost and efficient way to speculate on or hedge large intraday moves in the S&P 500. And their usage has spiked on days with key economic news like US Consumer Price Index (CPI) announcements. But the other side of the coin is that sellers of these options may be taking huge risks. Critics worry that large 0DTE options volumes could not only increase market volatility, but potentially lead to systemic risks in the markets.
In recent years, traders have been looking at shorter dated options than in the past. Why? Part of the reason is that they have deep liquidity in the market. Trading costs can also be a consideration. S&P options, such as 0DTE, are ultimately "cheaper" to trade at just 5 cents per tick, than say S&P futures, which are a minimum of 25 cents per tick to trade. Thus, some algorithmic proprietary trading shops are using these options in place of futures. Additionally, as volume grows, people tend to be mixing up their trading strategies to include 0DTE options.
Benefits for hedging
Short-dated options are rather unique in their hedging characteristics in that they allow firms to precisely hedge around macro announcements. Also because of their heightened gamma profile, they can be used to hedge equity crash risk or the gamma risk of other options in a given portfolio. Although, interestingly in a live poll given during the webinar, only about 7% of attendees reported using 0DTE options for this particular purpose.
What about modeling?
During the webinar, our panelist Russell was questioned on whether we should be relying on models that are familiar when using 0DTE options or if something else is needed. Russell remarked that models inevitably have their limits. Markets are not perfectly frictionless and can be incomplete, thus hedging is somewhat of an art rather than merely a science. It is just as important to apply expert judgement as it is to have the ideal model in place. In essence, there is a wide array of modeling approaches that can be used with short-dated options, but your overall strategy should win out over reliance on modeling alone.
What analytics should be looked at when assessing 0DTE options risk?
In addition to considering greeks, open interest and volume, it is not so much the type of analytics you are looking at when assessing risk of 0DTE options, but more importantly the speed of the analytics. Despite intraday moves being typically quite small, the reality is that these moves may be seemingly minor until something unexpected happens— and then they aren’t anymore.
When there is a crisis, time accelerates, and things can move rapidly. Thus, you need a degree of speed that you don’t need most of the time. But when you need it, you really need it. Whatever type of analytics you are using, you are going to want to see them in real-time.
Should we worry about systemic risk with 0DTE options?
The webinar panelists were asked to weigh in on if they thought the use of 0DTE options may lead to potential flash crashes like the Volmageddon crash of 2018, where a sudden spike in market volatility precipitated a one-day loss of more than 90% in the value of short volatility exchange-traded products (ETPs).
Panelists ranged in their opinions on the potential for systemic risk. But the consensus was, while possible, there is not a huge concern for a flash crash stemming from 0DTE options at this time. Russell added that when assessing any risk alarm bells as they relate to zero-day options, the most promising indicator is the gamma.
Get the full story...
Listen to the complete on-demand webinar recording here: Zero-day Options: Ticking Time Bomb or High Alpha Trade?