0DTE Options Significantly Impacting the Market
The increased popularity of 0DTE options among retail and institutional investors has made them a major market mover this year. Although options trading volume reached record highs, the growth in 0DTE contracts far outpaced all other expiry terms. Cboe data from August revealed that these short-dated contracts accounted for approximately half of S&P 500 options trading.
The Perfect Storm: Factors Amplifying the Sell-Off
When investors buy substantial amounts of S&P 500 put options, market makers who take the other side of these trades must hedge by selling stock futures throughout the day. In a weakening market, market makers typically sell at a faster pace to protect themselves, potentially exacerbating the downward movement. Nomura’s McElligott estimated that bearish 0DTE trades led to approximately $3 billion worth of stock futures being sold. Additionally, a large institutional investor engaged in an asset allocation trade involving selling equities and buying bonds, further increasing selling pressure on stocks.
This combination of bearish trades and institutional selling caught bullish investors off guard, resulting in a sharp reversal. Joe Mazzola, the director of trading and education at Charles Schwab, explained that stretched sentiment, low liquidity, and the catalyst of 0DTE options trades contributed to the market movement.
Potential for Further Volatility as Year End Approaches
Analysts express concerns that similar episodes of volatility may arise, particularly as the year draws to a close and expected trading volumes decrease. Matthew Tym, the head of equity derivatives trading at Cantor Fitzgerald, particularly worries that if unfavorable market news emerges, 0DTE options could amplify sell-offs. He emphasized the potential for these short-dated contracts to exacerbate market movements should negative conditions arise.