(Bloomberg) — This year's hottest derivatives trade, and perhaps the most controversial, drew attention one last time for 2023 as market watchers called zero-day options the villains behind Wednesday's plunge in U.S. stocks that hit the Rally ended.
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With the S&P 500 index in overbought territory and turnover limited by looming holidays, observers suspected that large amounts of put options that expire within 24 hours, so-called 0DTE options, were enough to trigger a market decline, the strongest in almost three months. Such trades would cause market makers on the other side of the trades to hedge their risk, which would push the market lower, the argument goes.
“We have been wary of 0DTE options for some time,” wrote Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald LP, in a note with colleague Paolo Zanello. “Today we experienced a late day sell-off which we believe could be caused or certainly exacerbated by 0DTE SPX options. The market environment was certainly ripe for it.”
They said trading in put options, which give buyers the right but not the obligation to sell an underlying asset, attracted attention in the 4,755-4,765 area. Data tracked by Bloomberg shows that puts on the S&P 500 with strike prices of 4,755 and 4,765 expiring on December 21 had a notional value of $15.4 billion and $11.7 billion, respectively, as of last At the close of trading, it was by far the highest value among the put options. Total S&P 500 put volume on Wednesday was the third highest in 2023.
The S&P indicator slipped during the day from as low as 4,778.01 and closed at 4,698.35. The 1.5% decline from the previous close was the largest since September 26th. The relative strength readings on the gauge were at levels typically seen before a decline. Wall Street's volatility gauge – the VIX – rose sharply from near multi-year lows.
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Several strategists had warned of the risk of a decline after the market posted an almost non-stop rally since late October that left indexes tense. On Tuesday, RBC Capital Markets strategist Lori Calvasina said the risks of a decline are now illuminating, while Fed officials have sought to dampen interest rate cut expectations over the past week.
“Long Put 0DTE on the S&P 500 is likely one of the catalysts that triggered the significant bearish reversal in US benchmark equity indices yesterday, in addition to short-term overbought conditions and weak trading environment ahead of the year-end holiday season,” said Kelvin Wong , a senior market analyst at Oanda.
Given Wednesday's selloff, a number of investors could bet on a further decline by buying more zero-day put options, which would prompt market makers to ultimately sell the S&P 500 via futures and mechanically drive the pullback, said Wong, “creating a…”potential negative feedback loop back into the S&P 500.”
Given the explosion in trading of zero-day contracts for every day of the week this year, debate continues over their broader implications. For institutional investors, zero-day-to-expiry options provide a way to hedge short-term risks and pursue strategies based on entering and exiting positions. For private investors, they offer an opportunity to make large bets with little money that may or may not pay off quickly.
While JPMorgan Chase & Co.'s Marko Kolanovic has warned that the product's popularity could repeat previous shocks such as the Volmageddon episode of 2018, Cboe Global Markets says there is little evidence that buying and selling the derivatives does Product destabilizes underlying market.
Options analysis firm SpotGamma said in a post on social media platform X that 0DTE options caused the US stock benchmark's decline. Rocky Fishman, founder of derivatives analytics firm Asym 500, noted that daily 0DTE volume of $900 billion was the highest since early October, which was notable given the lack of concrete economic news throughout the day.
– With support from Vincent Cignarella, Cameron Crise, Sid Verma and Abhishek Vishnoi.
(Updates with charts, data in paragraph 4, comments from Oanda in paragraphs 6 and 7)
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