{"id":195942,"date":"2023-09-08T10:30:00","date_gmt":"2023-09-08T14:30:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=195942"},"modified":"2023-09-08T13:13:00","modified_gmt":"2023-09-08T17:13:00","slug":"much-ado-about-0dtes-separating-fact-from-fiction","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/options\/much-ado-about-0dtes-separating-fact-from-fiction\/","title":{"rendered":"Much Ado About 0DTEs: Separating Fact From Fiction"},"content":{"rendered":"\n

Evaluating the Market Impact of SPX 0DTE Options<\/h2>\n\n\n\n

Trading in zero days to expiry options, so called 0DTEs, have exploded in popularity in recent years \u2013 rising from 5% of SPX\u00ae options volume in 2016 to over 40% since the introduction of Tue\/Thu expiries last year (Exhibit 1). In recent weeks, that share has grown even more, averaging 50% in August (Exhibit 2).<\/p>\n\n\n\n

As volumes have increased, so have concerns around the market impact of these products. Specifically, the fear is that market makers hedging these options could become outsized relative to the underlying S&P market, and therefore option \u201cgamma hedging\u201d (explained below) may be exerting undue influence on the market. Over the past year, commentators have blamed 0DTEs for everything from exacerbating<\/a> intraday volatility to suppressing<\/a> it, with estimates for market maker positioning ranging from \u201crecord short<\/a>\u201d to long $50bn<\/a> gamma in SPX alone. What\u2019s behind these often contradictory<\/a> headlines, and crucially, who is right?<\/p>\n\n\n\n

\"Exhibit<\/figure>\n\n\n\n

What is Gamma Hedging?<\/h2>\n\n\n\n

To answer that, it\u2019s important to understand what gamma hedging is and why it matters. Gamma refers to the change in the option delta as the underlying asset price changes. In the context of market makers delta-hedging their options positions, gamma is how much they will need to adjust their delta hedge as the underlying moves around. In this case, how much they will have to buy or sell in S&P futures in response to a 1% move in the SPX index.<\/p>\n\n\n\n

There are two things to pay attention to when it comes to market maker net gamma positioning. The first is the magnitude – the greater the number, the greater the potential market impact of the option hedging activity. The<\/p>\n\n\n\n

second is the sign. Being long gamma means that market makers would be hedging in the opposite direction <\/em>of the market move \u2013 if SPX index rallies, market makers have to sell futures, and if SPX index falls, market makers have to buy \u2013 and thus the hedging activity has the potential to dampen market moves. Being short gamma means market makers would be hedging in the same direction <\/em>of the market move \u2013 if SPX index rallies, market makers have to buy more futures, and if it falls, market makers have to sell \u2013 and thus have the potential to exacerbate market moves.<\/p>\n\n\n\n

High Volume \u2260 High Risk<\/h2>\n\n\n\n

Most of the concern around SPX 0DTE options arise because of their massive volume – averaging over 1.23m contracts ($500bn notional) a day in 2023. While the numbers may sound big, it\u2019s important to emphasize that volume doesn\u2019t equate to risk. High notional doesn\u2019t necessarily mean market makers on the other side of the trade will need to do a lot of hedging. What matters is the balance <\/em>of the volume between buys vs. sells, not the total size of the volume. To simplify, if 100k contracts trade on a particular strike and 50k was customers buying and the other 50k was customers selling, then despite ~$50bn notional trading on that line, the amount market makers need to buy\/sell in S&P futures to hedge is actually\u2026zero. Because the flow is perfectly balanced, market makers are left with net zero gamma risk despite the large volume in the options.<\/p>\n\n\n\n

\"Exhibit<\/figure>\n\n\n\n

So just how balanced is the customer flow in reality? While many commentators have tried to estimate that (to varying degrees of success), it\u2019s important to point out those are just estimates based on assumptions. Since 98% of the volume in SPX 0DTE options are traded electronically, most outside observers have very little visibility into the exact breakdown of the volume. However, at Cboe\u00ae, we do. As the exchange where all SPX options are traded, we can see for every transaction whether it\u2019s customer or market maker, buy or sell, opening or closing. As a result, we are able to get an accurate sense of market maker positioning by tracking their net position (long minus short) at each strike. What we find is that the flow is, in fact, remarkably balanced between buy vs. sell. Take Aug 15th<\/sup>, for example. Much has been written about the 4440-strike put where over 100k contracts traded on that day \u2013 yet if you<\/p>\n\n\n\n

look at the net positioning, market makers were left short only about 3k contracts (52k buy vs. 55k sell) by the end of the day, or just 3% of the gross volume. See Exhibit 3 above.<\/p>\n\n\n\n

Market Maker Gamma Analysis:<\/h2>\n\n\n\n

Once we have an accurate measure of market maker\u2019s net positioning for each strike, we can calculate an aggregate net gamma number. That number will tell us how much market makers\u2019 delta exposure in 0DTE options will change in response to a 1% move in the SPX index \u2013 and as a result, how much potential buying or selling in S&P futures they may need to do in order to stay hedged. The bigger the number, the higher the potential impact.<\/p>\n\n\n\n

So, just how big do the numbers get? The chart below shows you the range of market maker net gamma positioning throughout the day, taken in 30-min increments over the past year. The boxes tell you the interquartile range from the 25th<\/sup> to 75th<\/sup> percentile of the data (i.e. the middle 50% of the observations over the past year) with the median represented by the horizontal bar in the middle of the box. The \u201cwhiskers\u201d extend to the min\/max of 1.5x the interquartile range (anything beyond that would be considered outliers).<\/p>\n\n\n\n

\"Exhibit<\/figure>\n\n\n\n

A few key observations:<\/strong><\/h2>\n\n\n\n
    \n
  1. On average, market maker positioning is fairly de minimis, with net gamma exposure ranging from $170mm to<\/li>\n<\/ol>\n\n\n\n

    $670mm throughout the day. To put that number in context, S&P futures trade around $400bn a day, so we\u2019re<\/p>\n\n\n\n

    talking about potential hedging flows that make up between 0.04% to 0.17% of the daily S&P futures liquidity. As we<\/p>\n\n\n\n

    outlined in our 0DTE white paper,<\/a> the customer activity in 0DTE options tends to be very balanced because investors use them for a variety of purposes ranging from hedging to yield harvesting, tactical leverage to systematic trading. Unlike the meme stock craze during the pandemic era, we do not see customers trading 0DTE options predominantly for speculative purposes and thus leaving market makers short a lot of gamma. Nor is the product overrun by option sellers as has been suggested. We believe the balanced nature of the flow is a key reason why volumes in 0DTE options have remained robust through different market cycles (SPX index -19% in 2022 vs. +17% this year) as well as different volatility regimes (VIX\u00ae index in the 20-30 range last year vs. sub-20 this year).<\/p>\n\n\n\n