This year’s hottest options trade is catching on with Wall Street’s nerd contingent.
From Citigroup Inc. to JPMorgan Chase & Co. and UBS Group AG, banks that develop systematic equity products for clients have jumped on the bandwagon of derivative contracts that have zero days to expiration, or 0DTE. Desks responsible for so-called “quantitative investment strategies,” or QIS, have either built new trades around these flashy options or used them as an alternative in existing strategies.
The on-boarding by quants is the latest sign of acceptance for a breed of options that have boomed in the two years since their wider introduction. Part of it is simply down to the virtuous cycle of liquidity: As trading flourished, professional investors were bound to jump in. Now they’re being offered bespoke strategies using 0DTEs for everything from low-cost bets on volatility to portfolio diversification.
“It’s not difficult to convince people that the solutions are actually superior in terms of risk management,” said Michele Cancelli, global head of QIS trading and structuring at Citi, whose team this year started incorporating 0DTE in their line of offerings. “That’s absolutely well accepted and can be the beginning of something that is going to expand further.”
The pitches speak to just how quickly Wall Street’s quant factory — which by one estimate runs $370 billion in assets — can churn out products in response to market changes. With QIS teams at every investment bank packaging these trades into swaps and structured notes, there’s growing pressure to keep up with the competition.
At Citi, Cancelli and his colleague Guillaume Flamarion have led a charge into 0DTEs, bundling them up in a wide range of volatility-related products that hedge downside, harvest premium and juice up relative-value trades. In their view, there’s one big benefit from something with a shelf life shorter than 24 hours: minimal risk of being caught out by unfavorable overnight market moves.
By way of illustration, consider a trade that sells volatility — bets on market calm, essentially — on a monthly basis, making it vulnerable to big market swings over a relatively long period. 0DTEs let users short vol on a daily basis, at a proportionally smaller size. That way, it can achieve similar returns but with smaller ups and downs.
“There is a very good rationale for those zero-day options to have become very popular,” said Flamarion, Citi’s head of the multi-asset group for the Americas. “We have to create a full suite of strategies so that clients can really pick and choose, and customize their exposure depending on the objectives that they have.”
Intraday momentum trades offered by JPMorgan are another example of standard products being updated for the 0DTE world. The strategies were previously built exclusively out of index futures to ride reliable day-to-day stock patterns. Now they’ve added zero-day options to the mix.
The flurry of new products are expanding the list of use cases while potentially diluting concerns that 0DTEs’ proliferation threatens market stability and risks reprising past disasters such as the 2018 Volmageddon episode. As trading flows spread out, the peril of a one-sided market is lessened, has argued by Cboe Global Markets Inc., the exchange at the center of the trading boom.
Zero-day options emerged as products tailor-made for 2023’s markets, their uptake driven by traders trying to navigate incessant volatility amid an uncertain economy and evolving central bank policy. Partly because of their low absolute price tags — a $1 investment amounts to a $1,000 stock bet — the contracts quickly found their way into the mainstream, at one point capturing more than half of the S&P 500’s total options volume.
The deep pool of liquidity has lured users of all kinds, from market makers that flock to zero-day options to balance books to exchange-traded funds that sell them for premium income. Now, evidence is building that model-driven shops are capitalizing on the craze, too.
While 0DTE contracts look cheap at face value, the real cost as expressed by implied volatility tends to be higher than for options with a longer maturity. UBS, one of the first firms to employ ultra-short dated contracts in their QIS trades, last year launched the front-end short vol daily strategy to capture the elevated premium. Designed to sell out-of-money puts each day, the product attracts clients such as hedge funds, asset managers, family offices and pension funds, according to Spyros Mesomeris, global head of structuring at UBS.
“The strategy has been quite well received,” said Mesomeris. “It has quite a diversifying profile to that of existing strategies.”
At BNP Paribas SA, the QIS team has also added 0DTEs in their lineup of short-vol strategies. Thanks to a lack of exposure to after-market swings, the new trade has shown little lockstep moves with others focusing on long-dated contracts, and that makes it a favorable diversifying tool for clients, according to Xavier Folleas, head of QIS at the firm.
The challenge, he says, is closely monitoring positions and being nimble when the tide turns.
“We need to manage the position intraday. So it’s not only income generation with 0DTE by saying, ‘in the morning I will sell puts and OK, it’s my income.’” Folleas said. “You may have to buy back the position if the market reverses.”
The zero-day game has shown no signs of abating, entering Europe and spilling into other assets in recent months. For quants, the race to roll out 0DTE-linked trades is likely just starting, said Citi’s Cancelli.
“In any new markets, people want to see performance for a few months or a few years” before fully embracing them, he said. “We’re still in an early stage of competition.”
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