What the Dramatic Boom in Zero-Day Options Means for Stocks

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:16)

Joe, do you remember Armageddon? Oh, wait, let me start over.

Charlie McElligott (0:22)

I cried, I cried.

Tracy Alloway (0:24)

That's a great moment.

Joe Weisenthal (0:25)

Keep that in, keep that in, keep that in.

Tracy Alloway (0:27)

Do you remember Valmageddon?

Joe Weisenthal (0:30)

Yeah, if you asked me exactly when that was.

Tracy Alloway (0:34)

2018

Joe Weisenthal (0:35)

Okay, I wouldn't have, maybe I would have said 2017 or something, but yeah, something crazy happened and something with the VVICS and some ETN or something.

Tracy Alloway (0:45)

This is a moment in market, I'm still laughing, sorry. This is a moment in market history that lives for free in my head because a lot of interesting things happened. So for those who might not remember all the details, there were these two little volatility products to exchange traded notes that basically ended up having this huge impact on the market and specifically the volatility index, the VIX.

And so you had this kind of tail wagging the dog scenario where you had two products that ended up impacting the overall market.

Joe Weisenthal (1:20)

Yeah, and you know, what was really notable about the post 2010s environment is that just keeping a steady short volatility trade on was extremely profitable for years. And people sort of just get lulled into this because buy the dip was like this sort of dominant thing. You had the Fed sort of on your side, typically playing some role of the Fed put and all of that. And you had the residual anxiety of the crisis. So people were paying a large premium for protection, volatility protection. So being a seller of that and sort of being implicitly short volatility was just great until the one day it wasn't.

Tracy Alloway (1:56)

Well, this is why these two exchange traded notes came into being in the first place. It was because people wanted to be able to sell volatility. And I remember they became very popular with a certain faction of retail traders. There was even a subreddit called TradeXIV, which was the name of one of the notes.

It has since rebranded to TradingVault because we had this Volmageddon situation and both of these exchange traded notes ended up collapsing. So not only did they sort of spark this wider move in the market, but they ended up dying because of it.

Joe Weisenthal (2:31)

What's interesting in retrospect, and I hadn't really thought about this, but what's interesting in retrospect about this story is that, okay, in 2018, the retail move was like, okay, trade XIV or go long XIV, and that was sort of like how people played this. Post 2020, now you get the sense that retail is playing derivatives more directly, particularly call options.

Rather than some node or instrument that implicitly did that. Now, of course, the story of the Robinhood and all that is lots of people just getting directly into options trading.

Tracy Alloway (3:06)

That's right. And the big story in options right now, and the reason I brought up Volmageddon, not Armageddon, which thankfully hasn't happened yet, is because-

Joe Weisenthal (3:15)

We're recording this March 8th, so we'll say-

Tracy Alloway (3:18)

Thank you for the caveat. You never know. All right, so the reason why we're talking about Volmageddon is because you have this new type of option on the scene. They're called one-day or zero-day options, a zero DTE or one DTE, and they've kind of exploded in volumes in recent years. And there's a lot of discussion about whether or not they are going to lead to a similar Volmageddon type scenario where you have this small thing, although they're not that small anymore, but you have this small instrument that ends up having a cascade effect on the market and leading to a bigger effect on the S&P 500, the benchmark index.

Joe Weisenthal (3:59)

Right. And as always, there are these concerns that any sort of derivative instrument, which might be used for hedging purposes, could have this feedback loop. And of course, the classic there is like 1987

Tracy Alloway (4:12)

Black Scholes.

Joe Weisenthal (4:13)

And the stock market insurance, whatever they called it.

Tracy Alloway (4:16)

Portfolio insurance, yeah.

Joe Weisenthal (4:17)

And the other thing you note, and this is sort of what's interesting to me and why we're talking about this. It's like in 2021, I think we had a very good story for why there was so much of this sort of zero data expiry option trading, right? The story is like, oh, these new degenerate gamblers and they're on Robinhood and they're like trading these hyper volatile derivatives that they're short term bets and they're just being swings.