Rob Hocking, Cboe Global Markets’ global head of product innovation and the person heading its Cboe Labs innovation hub has said the growth in use of zero-day-to-expiry (0DTE) options has been a consistent theme for the exchange group.

As the pool of players widens out and people begin to test the waters of what is possible in this new short dated environment, changes are emerging in the market behaviour of a wider pool of market participants.

“Even large volatility players on the street, who have become active in these contracts, say the growth of 0DTE has led to one of the biggest shifts in how they’re managing risk, and changing the way they trade volatility,” Hocking added. “We’re really excited about the continued growth that we believe we will see. More and more industry participants are asking for our open/ close data source to back-test short-dated options trading strategies, and seeing how they can bring that liquidity pool into their existing execution playbook.

“Some firms are still in the early stages of figuring out how they can best use these tools today, and we see potential for continued growth and adoption over time.”

Where a systematic trader is using an overwriting strategy (selling protection where they see options are overpriced), the more exercise windows the trader can cycle through, the more opportunities they have to maximize the profitability of the strategy.

And even traditional indicators of a one-way market (such as the put-to-call ratio) point to a healthy ecosystem, counteracting the hyperbolic commentary that has sometimes attended the growth figures it has seen.

“So far, the vast majority of those strategies are defined risk trades, with what you might call limited downside,” Hocking said. “That would be the selling of spreads and buying of outright options across a wide range of strikes. What that does is limit concentration risk. As of July, 41% of all SPX and 0DTE trades were spreads. The balance were single-leg option orders, with the vast majority originating as buy or long orders. So that is limited risk and defined outcome trades, and the best way we can show that is that the balance of put/call ratios is typically around one to one in 0DTE. This is really much, much lower than the historical 1.5 to one put/call ratio that we’ve seen in SPX. We also see momentum trades, or trades serving a particular purpose – whether that’s trying to capture premium or yield overlay position.”

All of that is important because it forms the genesis of a significant recent move shepherded by the product innovation team at Cboe – the creation of the one-day VIX (VIX1D) index in April. Its original Volatility Index (VIX) launched in April 1993, providing a measure for 30-day implied volatility-based S&P100 options prices (switching to SPX in 2003). The measure became widely used by the market and led to the launch of futures and then options on the VIX in 2004 and 2008.

On the index side, Cboe added three-month, six-month and one forward implied numbers, and created a nine-day VIX in 2018. One thing none of those capture sufficiently is short-dated options to reflect that new trading flow. The 30-day calculation methodology for example only takes into account options that expire in the 23 to 37 day range.

“The VIX1D was created to answer customer demand for a volatility measure that captures trading in short-term contracts.” Hocking added: “That to us was a natural next step and expansion of the VIX Index suite. The other indexes just weren’t designed to capture extremely short-term signals. So, the intention was to provide a tool that would help market participants make more informed decisions around positioning and timing of their trades given the evolution of the market.”

The new index saw some wild swings just after launch, demonstrating the difference with the other measures and prompting some to ask whether there would be derivatives launched.

“We have no immediate plans to make VIX1D tradeable – nor to launch a product directly on this index,” Hocking commented. “That said, our process for product innovation always begins with first understanding our customers’ needs. So, while there was a clear rationale for launching the VIX1D index, we continue to take the time to educate market participants and make sure everyone knows how it works. Let the marketplace digest it, model it, and really understand it so that in turn, they can provide the necessary feedback to guide us in delivering the right tradable product. We’re in that process right now.”

To be continued on August 11