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The Cboe wants to ‘debunk’ some 0DTE myths

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As HL Mencken, Upton Sinclair or William Jennings Bryan was said to have roughly quipped, it is difficult to get someone to understand something when their salary depends on their obliviousness.

On an unrelated note, here is a take from the Cboe:

KEY POINTS Utility Short-term, specifically ODTE, options are effective tools for precise risk management and income generation in today’s fast-paced markets, allowing investors to better manage around specific events by reducing any residual overnight risk. Speculation Speculative trading with ODTE options is a subset of their usage, but not inherently negative; every investment involves some level of speculation. The limited risk nature of buying options and trading spreads contrasts with the potentially larger losses associated with stock ownership. Impact Despite high volumes, the market remains balanced and orderly, with a broad user base engaging in diverse trading strategies, creating liquidity across various strike prices.

That’s from a report the dominant US options exchange just published that aims to “set the record straight” and debunk some of the myths surrounding zero days to expiry options (0DTEs) — derivatives that expire the day they’re written.

Rather than the debauched and dangerous phenomenon of popular lore, the Cboe argues that 0DTEs are “remarkably well-balanced, liquid and orderly” and help foster a “dynamic market environment”. In sum:

Options are a time-tested and highly regulated investment tool that have been traded on registered and regulated exchanges for decades. The increased use of options should be embraced as they offer the potential for targeted investing, passive income, better risk mitigation and income generation. That seems like something every generation can get behind. 

Look, it’s true that the distinction between gambling, speculation, trading and investing is largely in the eye of the beholder. Even if you think there are clear distinctions, markets are healthier if there is a mix of all types of activity. As Fischer Black observed nearly 40 years ago, the resulting “noise” is actually valuable.

Moreover, the suspicion that the explosion of 0DTE trading is somehow a massive systemic risk has always felt a bit spurious.

For sure, it is natural to be sceptical of something that has grown so dramatically since its birth in 2022 and even seems to affect markets on some days. Some of us remember the violent delights of Volmageddon. But the very transient nature of 0DTEs means that their effect is, well, transitory. The risk is opened and closed on the same day. Moreover, the 0DTE market remain pretty modest compared to the massive amount of trading going on at an index level that they reference.

Lastly, these kinds of explainers are often useful, even when they are absurdly self-serving. As the dominant US options exchange the Cboe has better data on the phenomenon than other players. For example, based on trade sizes, complexity and frequency it estimates that financial institutions (probably trading firms and hedge funds) account for 60-70 per cent of 0DTE trading. In other words, this is not purely the YOLO retail trading community.

But Cboe is tying itself into knots attempting to show that 0DTEs are some kind of sober risk management tool. They’re not. They’re lottery tickets on financial market outcomes. People like to gamble, and other people like to make markets in those bets. And net-net the winners are not the gamblers but the casino.

As a paper published a year ago noted (Alphaville’s emphasis below):

We use recent exchange-related developments to identify option trades that originate from retail investors, and find that more than 75% of their trades in S&P 500 options today are in 0DTE contracts. While retail investors benefit from significant price improvements in the form of lower effective spreads, they experience large losses on average: between February 2021 and September 2023, retail investors lost $241,000 on an average day; since the introduction of a daily expiration calendar in May of 2022, this number has grown to average losses of $350,000 per day.

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