Happy Friday, traders…
Jeff here.
We recently passed the third anniversary of one of the most important days in modern trading history.
You may not have noticed…
But on June 21, 2021, something BIG happened in the options market…
The SPDR S&P 500 ETF (NYSEARCA: SPY) — the biggest exchange-traded fund on the planet — started offering Zero-Day-to-Expiration (0DTE) options every day of the week.
At first, this may have seemed like something that would only affect the most degenerate, ‘YOLO’ Reddit traders…
But now, it’s clear that 0DTE options are doing much more than that…
They’re shaking up the entire stock market.
With that in mind, let me show you how 0DTE options have changed the derivatives market forever (and what it means for your trading)…
How 0DTE is Changing the Stock Market
The shift to everyday 0DTE was a big deal because it changed how people could play options on SPY — the most widely traded ticker in the world.
And now, we’re starting to see the unignorable effects of this change…
Before this, you could only trade SPY options on Mondays, Wednesdays, and Fridays. If you wanted to execute short-term trades with SPY options, you had to plan around those three days.
But over the past few years, with SPY options expiring every day, traders have more opportunities to make speculative bets.
Since this change, we’ve seen a legitimate paradigm shift in the options market…
Never in the past 40 years has options trading been this popular. 0DTE contracts now account for 50% of all S&P 500 options volume.
Moreover, these new short-term options are causing some weird things to happen with the overall market…
For example, since the beginning of 2023, the Invesco QQQ Trust (NASDAQ: QQQ) has registered 19 months of trading.
Of those 19 months, 14 have been green.
This rangebound direction is happening because of leverage — using borrowed money to make bigger bets.
When institutional money and retail traders are using tons of leverage simultaneously, it exposes a vast number of market participants to an enormous amount of risk.
And a mysterious recent development tells us they’re taking on more risk than ever before, which could have wide-ranging implications for the entire stock market…
The Short-Dated Straddle Problem
I recently came across an article on my Bloomberg terminal that caught my attention…
It discussed how a high-risk options strategy is becoming more popular than the usual buy-and-hold method. As more traders get involved, it’s helping keep U.S. stocks trading in a narrow range.
This strategy involves selling both put and call options. When both options have the same strike price, it’s called a straddle. When they have different strike prices, it’s called a strangle.
Even though this trade can lead to catastrophic losses if stock prices move a lot, it’s currently helping to keep the S&P 500 index stable, making the strategy more successful in the short term.
The S&P 500 index has gone more than 300 days without a drop of 2% or more, reaching new highs thanks to tech companies.
Selling short-term options isn’t new, but now traders are not just selling calls against their stocks to collect premiums. They’re also selling puts, which means they could lose a ton of money if the market crashes.
The crazy part is this: This option-selling strategy is now looking better on paper than just holding stocks.
According to the Sharpe ratio, which measures risk and reward, selling daily straddles or strangles has been more profitable than holding major index returns over the past three months.
Because so many traders are selling short-term options, market makers end up holding both calls and puts, a position known as “long gamma.”
(Don’t know what “gamma” is? See a full breakdown of The Greeks right here.)
To keep their positions balanced, market makers need to sell the index when prices go up and buy it when prices go down, which hinders big intraday moves.
Around $10 billion worth of gamma is created with a 1% move in the stock market, and 90% of it disappears within a week due to the intense focus on short-term options trading.
Consider that gamma ramps exponentially. Now, imagine a 3% move down in the major indexes…
The gamma exposure won’t be $10 billion x 3 … it’ll be more like $10 billion x 30, $300 billion lost in a heartbeat.
These kamikaze traders are doing the equivalent of attempting to grab pennies in front of a steamroller.
This is late-stage bubble greed at its finest. Don’t get lulled into this tantalizing false bullishness.
I think it’s a trap. And when the bubble pops, it’ll end in tears for these 0DTE maniacs.
Bottom Line: 0DTE has changed the game forever, and we’re starting to feel those shifts in a major way.
Why I Never Trade 0DTE Contracts
Do I ever trade 0DTE options? No.
I may occasionally buy contracts and hold them to the last day, but I never buy options that expire the day I’m trading.
Why? Because I have 25 years of experience watching people get destroyed by day trading options…
The risk/reward on 0DTE contracts is terrible, especially considering the notable upside on slightly longer-dated contracts.
By buying contracts with more time on them, I give myself more wiggle room on the timing.
If I’m right, the week-out contracts will still pay out handsomely. But if my timing is slightly off, the weeklies lose much less premium than the dailies.
I don’t want my contracts to shed 50% of their value in 20 minutes, and I won’t be upset if my weeklies go up 100% while the dailies are up 200%.
That said, you need to understand what 0DTE is doing to the market, why the indexes are so rangebound, and how your trading choices should adjust accordingly.
Some traders, like Daily Strike Alliance member Bryce Tuohey, absolutely crush trading these contracts.
The SPY’s daily options have opened up new ways to trade, but they’ve also made it more important than ever to understand the intricacies of the options market.
Happy trading,
Jeff Zananiri
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