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The Popular Options Trade Turns a $1 Investment Into a $1,000 Stock Bet

September 19, 2023
minute read

A potent yet hidden force propels the year's most popular options trade, empowering both Wall Street professionals and day traders to leverage a mere $1 investment into a substantial $1,000 bet on stock movements.

Investors are immersing themselves in the daily fluctuations of American equity benchmarks through agile maneuvering in trading contracts with ultra-short expirations, often referred to as "0DTE" (zero days to expiry). These trading instruments require less upfront capital than what initially meets the eye, thanks to peculiarities in the derivatives marketplace that create the illusion of affordability for these options.

The phenomenon becomes most evident when comparing the actual expenditure on 0DTE options with their notional value, representing the exposure to the underlying asset offered by the contracts. For instance, the notional trading volume of 0DTE options linked to the S&P 500 averages a substantial $516 billion daily, as reported by data from Cboe Global Markets. Surprisingly, the premium, or the amount of money actually paid for these options, amounts to only $520 million.

To put it differently, traders gain $1,000 worth of stock exposure for every dollar invested in 0DTE options. Achieving an equivalent equity position using derivatives with a longer lifespan would necessitate a tenfold increase in expenditure, as demonstrated by analysis of Cboe's data.

Dennis Davitt, co-manager of the MDP Low Volatility Fund, aptly describes these zero-day options as the "fantasy football of option trading," where investors invest a dollar and await the outcome by day's end.

Unsurprisingly, these zero-day options have emerged as a favored tool for retail investors to engage in collective speculation, triggering concerns from institutions like JPMorgan Chase & Co. about the potential to amplify volatility in the broader market.

In this trade, buyers effectively spend $1 to control $1,000 worth of shares, with returns contingent on the price movement of these shares, typically in a magnified manner. They can either lose the $1 investment entirely or realize substantial profits.

The amplified leverage in this trade arises from the mechanics of derivative pricing. Contracts with limited time to maturity command lower premiums due to the reduced time available for the underlying asset to move favorably. This mirrors the concept of property insurance, where homeowners often pay less for six-month coverage compared to three years, as shorter timeframes carry lower risk. While the shorter-term package appears more economical, it may not necessarily offer better value.

For example, on March 22, when the Federal Reserve was poised to announce its monetary policy later in the day, the S&P 500 initiated trading around 4,002. At that moment, an at-the-money put option—a protective contract where the strike price closely aligns with the index's trading level—cost approximately $26, expiring on the same day. Conversely, a similar contract maturing two days later commanded an approximate price of $37—42% higher than the 0DTE option.

Jonathan Zaionz, senior derivatives analyst at Cboe, underscores the existence of precise use cases for 0DTE options that were not previously present. Given investors' shorter-term perspectives and hedging strategies involving 0DTE options, they are spared from paying substantial time premiums associated with longer-term strategies.

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Eric Ng
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Eric Ng
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