Zero-day options (0dte) and short-dated options volumes have grown exponentially in recent years and now eclipse the rest of the options trading landscape.
Trader TV speaks to Henry Schwartz from Cboe Global Markets on the latest episode of the Vol Show, unpacking the rise in popularity of the products and the specific nature of the symmetric flows between puts and calls, as well as the technological improvements associated with the product.
Schwartz discusses the emergence of protail (professional retail) market participants using more complex multiple-leg strategies to cash in on a low-volatility environment or to express differentiated directional views.
In this episode, he also looks at risks associated with the volume seen on screen, how open interest tends to remain low, and shares his views on how short-dated options could evolve.
Interview
Etienne Mercuriali How have zero-days-to-expiration options evolved?
Henry Schwartz Zero DTE and short-dated options has been the hottest story in the last couple of years. It’s actually been a gradual evolution. So at Cboe in the SPX, the S&P 500 index product, we’ve had Monday, Wednesday, Friday options for nearly 10 years. And in 2022, we added Tuesday and Thursday expirations, which gave traders the ability to trade daily options every day of the week, and in fact, they’re listed out about 30 days. Nowadays, we see the zero-day trading make up more than half of the activity in the SPX and the index products, but also in many of the major ETFs. And so currently, we see about two-thirds of the activity on a daily basis in the entire market in options that expire within a week. And in products like SPX and some of the big ETFs, it’s 55% to 60% of the flow is options that expire the same day they trade. Traditionally, SPX was a hedging instrument, used by the biggest institutional traders, right? So if you’re running a $5 billion portfolio, you might decide to buy some puts at certain times of the year to hedge your book. The shorter-dated options really have a different use case and a different user base, because SPX is a $6,200 index, so it’s very high-priced index. Typically, it’s not a very retail product, but in the zero-day options, because they’re so short-dated, the option prices are very low. And we actually see more than half of the activity in the zero-day options is coming from the retail trading community. I would actually call these traders protail because some of them are very sophisticated using specialized tools that help them automate or semi-automate their trading. The kind of sophistication we see in the Zero DTE trading from the retails, it really is a little bit like the quantitative investment strategies that we would see from a big bank.
Etienne Mercuriali I suppose for market makers on big days, or for retail selling the vertical spreads, managing the intense gamma at expiry must be difficult. How do they handle this?
Henry Schwartz So, SPX is a hybrid product, meaning that it trades in a pit in Chicago and also electronically. About 98% of the activity in the zero-day is purely electronic. The liquidity community in SPX, it’s probably the biggest in the entire industry. We have about 200 market makers trading almost $2 trillion a day in notional value in that pit. The liquidity community for the zero day option tends to be the same firm, but they actually segregate the business and they tend to run it as a specific team. What we see and what we know by talking to the liquidity community is basically they’re able to keep up with this flow for a couple of reasons. One is the technology they’ve built allows them to basically very, very actively manage their position. But the other thing that’s very important is it’s actually very balanced flow. So what we see in the longer dated SPX is a put-call ratio that’s close to 1.5. So basically portfolio hedgers come in, they’re going to trade more puts than calls. But when you look at the zero day trading, the pull call ratio is actually very near 1.0. So it’s almost a perfectly equal number of calls and puts trading on a daily basis. One other thing that’s very important about the zero day flow is even though it tends to be about 1.6 million contracts a day in SPX and you may see a couple hundred thousand contracts trade at a single option contract. The net positioning is actually very small because of the way that the flow is coming in, dominated by retail activity, the positions are being managed dynamically by both the buyer and the seller. And so we never see the positions getting very large. We can see in the data basically the net positioning is less than 10% of the total volume on any individual strike. The positions don’t seem to be getting that big and the community has learned very quickly to manage them and seems to be doing a fine job at it. There’s two primary types of order flow in the zero day options. One of them is simply buying options, tactical positioning. Taking advantage of the leverage that an option has in it to express the view. The other and actually probably more dominant is premium selling in the form of vertical spreads right which cap your risk. And when you do a call spread and a put spread they’re both out of the money. That’s called a condor trade. That really is one of the most popular strategies you see from retail. Even with volatility lower we continue to see that activity and actually seems to be successful. In fact on the really volatile periods , if you think about August of last year and April of this year, that activity actually dips a little bit. So the retail traders kind of stay away from the really, really volatile period. And then they’re actually much more comfortable in the market when things are quiet. So, you know, this year, VIX is around 16. It really, we really are back to, you know, kind of the low end of the historic range. But we continue to see retail and protail using zero day options. And the fact that we’re seeing a consistent, you know 1.5, 1.6 million contracts a day in the activity. It shows us that they’re having a good experience and that they are achieving their goals, whether that’s profit or the kind of exposure adjustment that they want.
Etienne Mercuriali My last question, Henry, for today, looking ahead, what do you see as the future for the product?
Henry Schwartz Longer trading hours is already possible in SPX. So we have something called the global trading hours that starts at 8.15 p.m. New York time and runs all the way till 9.25 the next morning. And then the regular session starts at 9.30 and goes till four. And we actually have an extended hour after that. You know, so we’re close to 24.5 in that product already. You can also trade VIX options and XSP, which is just a mini SPX contract. We may see additional products added into that. There’s a lot of talk about 24-hour trading of equities themselves, which may facilitate longer trading hours for some of the other products. But we also wanna be very careful about the liquidity. I mean, that’s what really makes this product so successful. And so we do a lot of work watching, you know, how wide are the markets, how large are the markets, how does it compare in the overnight session versus the day session. So it’s very important that the liquidity needs to be there in the underlying product. And then the derivatives themselves can become liquid. And so, you know, things all kind of have to march forward at the same time. But I think we’ll see it probably sooner rather than later.
Etienne Mercuriali I would like to thank Henry for his insights today, and of course you for watching. To catch our other shows, including Trader TV This week, every Monday at 6.45 am UK time, go to TradertV.net.
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