This way to make short-term market bets is gaining popularity, and raising concerns

Options trading has exploded in the last few years, and recently a particular type of options trading has become popular with retail and institutional traders alike. Zero Days to Expiration options (0DTE) are contracts that expire and become void the same day that they’re traded. Business is so strong that the ETF industry is looking to get in on this. Why are they so popular, and what impact might they have on prices in indexes like the S & P 500 and individual stocks? The options business is exploding First, the options business is growing fast. Volumes in both single-stock options and index options are tracking at record levels in 2023, according to data compiled by PiperSandler: Single-stock options averaged 40.8 million contracts traded per day in the first half of 2023, up 6% vs. the same period last year. Index options averaged 3.7 million contracts traded per day in the first half of 2023, up a whopping 43% vs. the same period last year. By contrast, stock trading is anemic. Cash equities volumes are down 11% in the first half of this year compared to the same period last year. Enter 0DTE options 0DTE options are monthly or weekly options that are principally traded on the final day of the contract, and are typically index options like the S & P 500 , but they can be single stock options as well. They are not new. 0DTE trading has occurred since 1973, when options became available. What is different, Cboe officials tell me, is that investors are now opening new positions and not just closing existing positions on expiration day. According to Cboe, 43% of the volume in the June 2023 options contract was trading that occurred in options expiring the same day. The expansion of monthly and weekly options in the past few years is largely fueling the increased volumes, according to Patrick Moley, an analyst who studies trading trends at PiperSandler. At the start of 2022, Cboe only had Monday, Tuesday and Friday expirations on its weekly S & P 500 options, Moley told me. In May 2022, it added Tuesday and Thursday expirations, which gave customers the ability to trade options expiring Monday through Friday. “Since then, 0DTE volumes have tripled and have gone from ~30% of CBOE’s total SPX option volumes to ~45% currently,” Moley said. Who’s using these products? “These products make a lot of sense for professional investors who want to buy a product that hedges them on, say, the day Apple’s earnings coming out,” Michael Green, chief strategist at Simplify, told me. It would also make sense that market makers use them to hedge as well. Moley said his initial impression was that most of the increased volume was driven by retail investors “gambling” on intraday S & P moves, but “we believe that institutions and market makers are increasingly using these products to hedge their daily market exposures as they are a cheaper and more efficient alternative to futures.” However, retail investors do appear to be a significant percentage of the volume, and some of the volume from market makers is also due to the need to hedge positions from retail traders. How do they work? One simple strategy with a particular appeal for retail investors might involve “harvesting” a premium. Say an investor gets up and believes the S & P 500 is going to end the day higher. He or she could open a position in the morning by, for example, selling a put (a bullish call) in the S & P 500 for the options contract that is expiring that day. The investor would collect a premium, say $2. If the S & P 500 did rise, the put would expire worthless, and because the contracts are cash settled the investor would pocket the difference between the premium he collected and the final price of the option. What’s the appeal to retail investors? Most people lose money trading options in general. Students of behavioral economics, which studies the way investors behave, will notice an immediate appeal to this type of trading: You can speculate with relatively small sums of money, and most importantly there is a cash settlement and the play is for one day, and then you win or lose. Next day, you can do it again. And again. And again. That appeal, Green tells me, is part of the danger of allowing ever-escalating bets on the short-term direction of the stock market. “This is a very profitable business for market makers and exchanges. But we are we just turning the stock market into a giant casino where people are putting money down on a roulette wheel?” he said. “This really appeals to the underlying gambling dynamic. Most people lose money trading options in general, and all this does is allow them to lose money more consistently.” The ETF industry is going to jump in If somebody’s making money somewhere (and the people who make money are the market makers and the exchanges), you can bet the ETF industry is going to find a way to get in on the action. The heavy flows have attracted the interest of the ETF industry, which is looking to launch new options trading products soon. There are ETF fund families like Simplify that already have ETF products that sell options. “There are no ETF products like this [0DTE] now, but they are definitely coming,” Green said. Do these products pose stability risks? “We don’t know if these will have an impact on the market yet,” Green said. But he did note that the shorter the date of the option, the bigger the impact of the price move on how many shares need to be purchased for hedging purposes. “We don’t know [what the ultimate impact will be], but they are having a bigger impact on pricing and trading volumes than the products that preceded them,” he said. He noted that years ago there were only quarterly options, then one month, then one week, now one day: “This increases the impact of the options on the underlying securities.” For example, he noted that big moves in stocks with large 0DTE positions could be a significant part of the trading in the underlying stock. “In a 2% move in Apple, these zero-day options would represent roughly 20% of the total volume in Apple that day, because market makers have to go out and hedge,” he said. Ed Tilly, CEO of Cboe, and Michael Green, Simplify chief strategist, will be on ETF Edge on Monday at 1:10 PM ET. .

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