IS 0DTE A THREAT? -> BofA's Global Equity Vol Team on 0DTE Options Flow Characteristics

The dominant flow theme recently in US equity derivatives has been the sharp increase in S&P 0-day-to-expiry (0DTE) options, which now account for 40-45% of total SPX options volume compared to 21% on average in 2021

Questions naturally abound regarding who's involved, typical strategies being employed, and potential market impact, with some raising the alarm that directional end-users are net short out-of-the-money 0DTEs, thus sowing the seeds for a "tail wags the dog" event akin to the Feb '18 "Volmageddon".

However, a closer study of intraday trade-level data suggests reality is more nuanced...

Half of all SPX 0DTE options trades are "single-leg auto-execution" (Exhibit 10) - a category for which 75% of trades occur near the bid or near the ask.

The % of trades near the bid (or ask) is greater than any other tenor. (Exhibit 11)

Volume is uniquely skewed towards the ask early in the day but towards the bid later in the day.This is consistent with 0DTE option buyers opening positions in the morning, and then unwinding as the day progresses. (Exhibits 12 & 13)

Second, near-ATM 0DTE Implied volatility typically trades at a 10-15 vol point premium to longer-dated tenors. (Exhibit 14)

These 0DTE Implieds often trade at a massive gap to S&P intraday realized volatility. The volatility risk premium (VRP) embedded in 0DTEs is typically 2.5x larger than for longer-dated S&P options, and at levels that are likely inconsistent with a market that has been overrun by option sellers (Exhibits 15 & 16).

Third, while we are aware of services that appear to cater to retail investors and offer automated intraday execution of risk premium harvesting strategies like Iron Butterflies & Iron Condors (continuing a longstanding tradition in the US of retail involvement in longer-dated SPX option selling programs for income generation - history also shows the merit of owning 0DTE "lottery tickets" despite paying inflated vols.

Indeed, owning SPX 0DTE 10-delta calls (Exhibit 17) or puts (Exhibit 18) during fixed 1-hour intraday intervals in 2022 would have frequently yielded (net) payout ratios exceeding 5x, with upside to 20-25x on occasion.

This isn't to say that 0DTEs can't be "weaponized" in the future to exacerbate intraday fragility and/or mean reversion. However, the evidence so far suggests that 0DTE positioning is more balanced/complex than a market than a market that is simply one-way short tails.