Impact of Zero DTE Options on the Market

Zero DTE (0DTE) options, also known as “same-day expiration” options, are financial derivatives with expiration dates on the same day they are traded. These options offer traders the opportunity to profit from short-term price movements in the underlying asset. Due to their extremely short time frame, zero DTE options are speculative and carry significant risks.

The increase in the trading volume of 0DTE options has sparked various concerns among market participants and prompted intense discussions in the media. The main concern revolves around the potential destabilization of the underlying market due to large open positions in 0DTE and other short-term options.

Reference [1] examines whether 0DTE options significantly impact the market. The authors pointed out,

We do not find evidence that the 0DTEs option open interest gamma propagates or unconditionally increases the underlying index volatility. Instead, our results suggest the opposite: higher 0DTE and other short-term options open interest gamma, measured by combining open interest at the market open and options’ dollar gammas shortly after that, is associated with lower realized volatility within the day and does not propagate overnight and lagged intraday volatilities…

We observe that positive shocks to 0DTE trading volume in recent years are indeed associated with and followed by higher trading volume in the underlying market and vice versa. However, these responses are not economically significant and dissipate quickly. The change in market structure in recent years also makes the underlying market return react stronger to shocks to 0DTE trading volume relative to earlier periods when 0DTE trading was negligible. However, the difference in the magnitude of absolute return response to 0DTE trading across the early and later sample period amounts to only 0.1 standard deviations of the absolute return, which is economically negligible.

In short, the paper concludes that 0DTE options do not destabilize the market. The increase in volume has an insignificant influence.

Another interesting finding of the paper is that 0DTE options have the largest volatility risk premium (VRP). This intuitively makes sense, as they carry more risk, hence the sellers would require a higher compensation for bearing the risks.

Let us know what you think in the comments below.

References

[1] Dim, Chukwuma and Eraker, Bjorn and Vilkov, Grigory, 0DTEs: Trading, Gamma Risk and Volatility Propagation (2024). https://ssrn.com/abstract=4692190