Since the beginning of 2022, an option-trading strategy that first found favor among retail traders and denizens of Reddit’s “Wall Street Bets” forum has caught on among Wall Street professionals with important consequences for the U.S. stock market.
As a result, traders can trade 0DTEs every day of the week, which has helped to enable the surge in trading of this extremely risky option products. Risks for dealers are magnified because these options are so extremely “convex,” meaning small moves in the underlying asset or index — often the S&P 500 — can drive large shifts in the value of the option. An option is “in the money” when it can be exercised or sold for a profit.
0DTEs impact how dealers hedge their exposure Typically, end users of options are net buyers of 0DTEs, according to Morgan Stanley, requiring dealers to carefully hedge their positioning. During at least two-thirds of trading sessions, 0DTE trading flows are powerful enough to flip dealers’ hedging positions, contributing to more seemingly unprompted intraday swings in highly liquid equity indexes like the S&P 500.
0DTE traders favor risky out-of-the-money bets Typically, buyers of longer-dated option contracts prefer strike prices that are closer to the market price of the underlying asset, the Morgan Stanley team said. But traders in 0DTEs tend to buy options that would only pay off in the event of a large intraday move.
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