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A new wrinkle in the SPX 0DTE saga

Updated: Oct 1, 2023

We've recently experienced some interesting changes in the 0DTE trading dynamics within SPX that warrant attention.


Short-dated options frenzies in stocks


Before we go into the details, though, I want to share some background. I've been studying short-dated near-to-the-money options flows for several years in-depth. I started because I was curious what was driving some of the incredible moves in stocks. Particularly some of the smaller to midcap stocks that were running wild.


I noticed a pattern. During the day we would see buyers aggressively purchase near-to-the-money (NTM) and close-dated options. Once price approached the most purchased strike, we'd often see buyers 'ladder up' to the next strike.


During this process, dealers are hedging delta, and call buyers are enjoying a sizable amount of leverage based on that same delta. That is to say, call buyers are able to command a sizable amount of buying power by positioning themselves into higher delta options. They enjoy the asymmetry of defined downside risk and maximal upside potential, while simultaneously moving the price of the underlying provided they are purchasing in size.


This sort of activity was especially common in highly shorted stocks with low floats (50M or less), and I spent time building scanners to identify this sort of activity, which led to some excellent trading opportunities both back then, and even in the present as we've seen a resurgence of this activity of late.


Enter the 0DTE SPX casino


In 2022 we saw an increasing number of expirations for SPX options, bringing them to once every trading day. That led to nearly 50% of daily volume expiring within 24 hours.

Total volume also surged, to the highest levels we've ever seen, combine this with the above, and you can see just how prolific the SPX options casino has become. It really is the tail that wags the dog of the broader equity market.

While volume in options surged we saw 70% of the total amount of notional value changing hands happening in options (as opposed to futures, ETFs and stocks). A record by any measure.

A change of character


Of late we've seen a rather curious trend emerge. Where ATM put premium is being sold to fund the buying of NTM calls in SPX. This leads to a rather curious paradigm during the trading day. When we see a sell down, usually to a key level, we see a rash of put selling and call buying happening almost simultaneously.

Since at least Thursday of last week this trend has been more pronounced. Those that are simply selling ATM since late March are making money. But if they are also buying 0DTE calls at the same time that's where the real potential is unlocked according to this trading strategy we've seen institutional players utilizing.


What's also changed, and is quite interesting to observe, is that institutional 0DTE traders are also 'laddering up' the strikes they play. Yesterday we saw 4130, 4135, and 4140 swept sequentially. We saw similar trading behavior on Thursday as well. To contextualize this change, it is quite reminiscent of what I've observed during options-driven short squeezes in single stocks.

The net result is not only the compression of volatility, but also the limitation of downside potential during the trading day when this strategy is utilized. It also means that the prior strategy of looking for the single most active strike, particularly in calls, does not in effect create a ceiling for price. These traders are now 'laddering up' while simultaneously selling ATM puts to further fund this trade.


Closing thoughts


If large institutional traders are selling ATM puts, they have to "know something". A trade like that could massively blow up if you aren't able to steer the market intraday.


It's pretty clear that some of the footprints we're seeing here are helping to prop up stock prices while simultaneously providing some degree of exit liquidity for large firms. After all, it's drawing in a lot of retail and even managed long-only funds.


Something that Horse and I first discussed about two months ago. If you haven't seen the video, check it out here.

4 Comments


Very good analysis! Any thoughts on conditions that would lead to a higher probability of this strategy blowing up?

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Markets & Mayhem
Markets & Mayhem
Apr 19, 2023
Replying to

Thanks, Dave! An extreme negative catalyst that overwhelms this strategy with selling would be my first thought.

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Aleš
Aleš
Apr 19, 2023

Mayhem strikes with yet another fascinating research piece! Great writeup, thank you!

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Markets & Mayhem
Markets & Mayhem
Apr 19, 2023
Replying to

Thank you, my friend.

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