Zero-day options dominating stock market's key corner, possibly posing significant risk

Zero-day options, a type of options contract that expires on the same day it is issued, have become a significant force in the stock market. Despite some dismissing them as mere gambling, these high-risk, high-reward options have gained popularity, particularly during the meme-stock craze of 2020 and 2021. By narrowing the expiration to a single day, these options allow for quick turnaround and potentially large profits, but also carry the risk of significant losses.

The Chicago Board Options Exchange (CBOE) further expanded the availability of zero-day options by launching one-day contracts for broad indexes in September 2022. These options now make up 50% of total S&P 500 options trading activity, according to JPMorgan. While institutions primarily use these options for hedging and income generation, individual investors account for about 30% of trades.

The risk associated with zero-day options is twofold. On an individual level, investors can lose all the money they spend on options. However, on a broader scale, if these options reach a substantial scale, they could contribute to increased volatility and wild swings in the market. JPMorgan warns that large moves in the market could trigger cascading trades, resulting in significant intraday buying or selling on the order of roughly $30 billion.

In addition to individual trading, Wall Street has also embraced the zero-day options trend. Defiance recently launched two exchange-traded funds (ETFs) that utilize zero-day options on the S&P 500 and Nasdaq 100. These ETFs aim to provide consistent yield distributions and exposure to the equity market. While the assets in these funds are currently modest at $20 million, JPMorgan suggests that if they grow substantially, they could have a sizable impact on the stock market, similar to the short volatility ETFs that caused a sell-off in February 2018.

Overall, zero-day options have become a significant presence in the stock market, attracting both institutional and individual investors. While they offer the potential for quick profits, their high-risk nature and potential impact on market volatility raise concerns about their long-term effects. As these options continue to gain popularity, regulators and market participants will need to closely monitor their impact on market stability.


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