Zero-day options: timebomb or new normal?

IFR 2491 - 08 Jul 2023 - 14 Jul 2023
7 min read
Christopher Whittall

When the S&P 500 leapt more than 5% in one day in November, analysts pinned the move on a better-than-expected inflation print. But derivatives traders identified an additional culprit: a US$7m wager using ultra-short-dated options contracts ripping through stock markets.

Volumes in same-day expiry options have mushroomed over the past year to account for almost half of all option activity on the S&P 500. That is stoking a fierce industry debate: is this breakneck expansion laying the seeds for the next crisis in the world’s largest equity market?

For all the dire warnings, various gauges show options markets are taking this fast-tracked revolution in their stride. Whether it’s the ratio of calls to puts, buyers to sellers, or institutional to retail investors, the data present a picture of a remarkably well-balanced market showing none of the tell-tale signs of imminent implosion.

And yet that hasn’t been enough to dispel concerns in some quarters about the havoc zero-day options might wreak in stressed markets. These products are highly leveraged by design, meaning they could amplify price moves should the market suddenly break out of its usual state of equilibrium.

“These options have only been around for a year and we haven’t seen the market being properly tested in a crisis environment,” said Garrett DeSimone, head of quantitative research at data provider OptionMetrics.

Cboe last year started offering weekly S&P 500 options expiring on every trading day when it added contracts ending on Tuesdays and Thursdays. That turbocharged growth in these markets almost overnight.

Average daily volumes have reached 1.2m contracts in 2023 from 281,000 in 2021, according to Cboe. Zero-day options now account for 43% of total S&P 500 option volumes compared with 21% two years ago as activity has comfortably outstripped the expansion in the broader market. Volumes have continued to hit record levels this year even as equity volatility has slumped, with the contracts proving wildly popular with a range of users.

“It isn’t just coming from one investor type: we’re seeing the full spectrum of users with different profiles and different approaches,” said Arianne Adams, head of derivatives and global client services at Cboe Global Markets. “There’s a diverse number of participants with a diverse number of trading strategies.”

Broad universe

Pinning down the precise make-up of the zero-day community is tricky. Nearly 90% of trades are routed through retail brokerage platforms, but those platforms are also used by institutional investors like hedge funds. JP Morgan strategists reckon only 5% of trades are traditional retail, while Cboe puts the number at more like 40%.

For institutional investors and bank traders, zero-day options have become the most precise tool around for tactically managing equity market risk. Those wanting to hedge the latest inflation or jobs number can now buy an option that rolls off the same day rather than having to pay for protection over an extended period that they might not need.

And there’s every reason to believe the ecosystem will continue to broaden and evolve. Adams said Cboe is receiving “copious” data requests from institutional investors, including systematic and quantitative investment funds looking to build strategies in these markets.

“There’s a sticky component to this activity. Vol arb, proprietary and even some market-maker firms are finding that the liquidity in this product is a better match for the risks in their portfolio. That’s what causing this to expand,” she said.

That diversity has created arguably the most balanced product in equity option markets. The put-to-call ratio (showing the difference in demand for bets on the S&P 500 falling or rising) has averaged 1.03 over the past 12 months, Cboe said. That compares with a ratio of 1.94 in favour of puts for S&P 500 options with more than one week to expiry, showing how investors have traditionally used these products for protection.


The market is not “a powder keg waiting to blow”, said Nitin Saksena, an equity derivatives strategist at Bank of America, because of the typical balance between buyers and sellers seen so far. But there are still features of zero-day options that could make them dangerous if the market suddenly gets out of kilter.

“The risk scenario is the customer weaponises the product in a stress event to chase the market higher or lower in a way that could challenge even the most sophisticated market-makers. It’s a behavioural wildcard,” said Saksena.

The concerns stem from the fact that zero-day options are highly leveraged products. While these options are now nearly half the market by volume, they only account for 7% of the total dollar value of money changing hands, according to BofA.

This means a trader can control a lot of notional by spending only a small amount of option premium. That dynamic has led to scrutiny of events like the jump in the S&P 500 in November, when traders say a call option costing US$7m in premium was left open all day and accumulated into a US$130m profit, fuelling a sharp rally as market-makers scrambled to hedge their positions.

“There’s a lot of question marks as to whether the option end-user community can actually turn the S&P into a meme stock: can they become directly aligned in their usage of the product in enough size that it actually moves the underlying market?" Saksena said.

Around 60%–65% of zero-day options opened in the morning are closed in the afternoon before the end of the session, Cboe said, lowering the chances of an accumulation of large positions exerting pressure on the market. The exchange said it had observed limited to no concentration of trading in the same options strikes – an important difference to the meme-style trading of past years when investors piled into the same type of one-way bets.

Stuart Kaiser, head of US equity trading strategy at Citigroup, said there does seem to be some loose relationship between intraday volatility and zero-day volumes – although the cause and effect is hard to nail down. He also said there tends to be more calls trading on days when the market is rising and puts when the market is falling, raising the question of how much the contracts can push the market one way or the other.

Even so, market-makers should by now be alive to the risks from this activity, particularly on well-known event days with economic data releases or central bank meetings.

“I’m a little less concerned that this’ll cause the next big sell-off in markets,” said Kaiser. “Even if you trade at the open, you’ve got exposure for seven hours. The positioning all resets at the end of the day. For this to be really disruptive, it needs to be very disruptive in a very short period of time.”