Zero-Day Options Are Like Betting on ‘Horse Race,’ Tchir Says

(Bloomberg) — A surge in short-dated options trading, driven by risk-taking behavior from investors, is amplifying daily moves in the stock market, according to Peter Tchir at Academy Securities.

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“People are really literally gambling,” Academy’s head of macro strategy told Bloomberg TV and Radio Thursday, adding “it’s almost like watching a horse race.”

“Volumes have exploded,” said Tchir. “It’s why we’re seeing moves that just are amplified — so maybe something that would be a half-percent move based on the news becomes a 1.5% to 2% move and it’s going in both directions.”

Market watchers have been drawing attention to the sudden madness for those contracts with shelf lives shorter than 24 hours, known in the industry as zero-day-to-expire options or 0DTE.

Taken up by retail traders in 2021 as meme stocks surged, these options have also gained popularity with big money managers — Goldman Sachs Group Inc. says that they made up more than 40% of the S&P 500’s total trading volume in the second half of 2022.

The uptick in their use has made the task of figuring out the market’s collective thinking on the economy difficult to decipher of late. Thanks, in part, to the increased use of the derivatives, stocks have been enduring violent reversals and large intraday swings.

Tchir has an explanation for how 0DTE options can amplify daily moves: take, for instance, a hypothetical scenario where the SPDR S&P 500 ETF Trust (ticker SPY) starts the day trading around $400. An investor buys an out-of-the-money call betting it could go to $405. The options dealer who sold the call then has to keep buying the underlying security — to keep a market-neutral stance — driving the price of SPY higher. At that point, other investors might jump in to bet on it going to $408 — and the cycle continues.

He views it as almost a laddering-type trade which occurs over and over. “It reminds me a lot of what we were seeing about a year and a half, two years ago where you had those gamma squeezes,” Tchir said. During the meme frenzy in early 2021, day traders used short-dated options to bet that as the value of the shares got closer to an option’s strike price, dealers would have to buy more and more of the underlying stock.

Earlier this week, JPMorgan Chase & Co.’s top-ranking strategist, Marko Kolanovic, warned the explosive trading in 0DTE options is creating an event risk on the scale of the stock market’s early-2018 volatility implosion. By his team’s estimate, daily notional volume in such short-term options is around $1 trillion.

Tchir says a selloff is likely to draw regulatory scrutiny. There are other signs that animal spirits are raging in the market. Meme-like stock moves are once again shaking stocks including Bed Bath & Beyond Inc., which skyrocketed even after the company indicated it was preparing for a potential bankruptcy filing.

“People are going to start looking at this,” Tchir said. “My Twitter feed is filled with people who promise to make $1,000 into $100,000. It’s truly gambling.”

–With assistance from Jonathan Ferro, Lisa Abramowicz and Tom Keene.