Understanding the Market | Will zero-day options trigger a stock market crash in the US?

Intelligent Financial APP noticed that two years after Wall Street's frenzy over rapidly expiring stock options began, the latest Markets Live Pulse survey shows that this unprecedented prosperity still has room for continued growth - although nearly half of the respondents are worried that it will eventually collapse.

In April, the nominal value of zero-day expiration contracts for the S&P 500 index reached about $862 billion. Among the 300 respondents in MLIV Pulse, nearly 90% expect this growth to continue. When it comes to the question of whether it will end in steady growth or disaster, their opinions are almost evenly split.

Due to both small and large investors seeking to avoid economic and central bank policy uncertainties, zero-day stock derivatives (referred to as 0DTE) with less than 24 hours until expiration have become one of the most popular trades on Wall Street. Last year, 0DTE trading accounted for 45% of the total trading volume of S&P 500 index options, roughly double the amount before the widespread listing of this product in the second quarter of 2022.

"By allowing daily options trading, exchanges are making a killing. As you can see, trading volumes have increased as more and more people can use it," said Phil Pecsok, Chief Investment Officer of Anacapa Advisors. "They will only become more and more common."

The scale of this prosperity has sparked controversy. Some investors are concerned that the trading activity of ultra-short-term options may affect stock market volatility, and studies have shown that retail investors using ultra-short-term options are mostly losing money.

Most survey participants are aware of the latter risk, with 56% believing that using these tools is easy to lose money. However, this concern has not extended to restricting retail investors from accessing 0DTE, with 76% of respondents (nearly two-thirds of whom are professional investors) stating that making 0DTE easily accessible to retail investors is fair.

Zero-day options were originally used by high-frequency traders to speculate or hedge positions, and are now favored by seasoned quantitative professionals and small investors. They have also found their way into the ETF space.

Academics and researchers on Wall Street have pointed out the potential dangers of this wave of trading, including the possibility that it may lead to greater intraday market volatility. JP Morgan strategist Marko Kolanovic warned that their popularity could replay past disasters, such as the 2018 Volmageddon, when a famous collapse shattered the long-term calm of the U.S. stock market. The theory is that significant market fluctuations may force options traders to liquidate positions in large numbers, accelerating selling. Options traders are the other side of the trade and must buy or sell stocks to maintain a neutral position in the market At the center of this wave, the Chicago Options Exchange believes that the widespread use of 0DTE implies that these trades will not result in the kind of crowded one-way bets that could make the market vulnerable to shocks. About two years ago, the Chicago Options Exchange extended the expiration date of the S&P 500 index options to every business day, and later allowed zero-date options for the Russell 2000 index.

In its latest expansion, Nasdaq Inc. has announced plans to add short-term options for commodities and U.S. Treasury ETFs.

In a survey by MLIV, opinions on the impact of 0DTE on the underlying market were fairly evenly split. Only about a quarter of respondents said they were very concerned, 34% were not concerned, and 41% were just a little concerned.

When asked how they would describe 0DTE, the contributors to MLIV Pulse - mainly from the U.S. or Europe - often used sharp language. "Gambling" is the most common description. "Las Vegas slot machine," "atomic bomb," and "a tool that transfers wealth from retail and immature institutions to exchanges and market makers" are all negative descriptions.

Positive contributors mainly focus on their utility as hedging tools. As one participant put it: "For investors, this is a relatively inexpensive way to establish positions in the directional movement of stocks without holding the underlying stock."

So far, 0DTE is only applicable to major indices and ETFs. The popularity of zero-date contracts has sparked speculation that they may expand to cover individual stocks. When asked about this potential expansion, respondents' opinions were completely different.

Nearly half of the survey participants believe that 0DTE should not be applied to individual stocks