Notes from the Options Industry Conference

I just spent the past three days quite productively at this year’s Options Industry Conference.  Once again, I was privileged to participate on a first-day panel.  This year’s was a high-level discussion about the state of the options industry.  Our main topics of discussion follow.

Volumes are exploding and have been doing so since Covid.  Industry volumes rose roughly 50% per year in 2020 and 2021 and have continued to increase at double-digit percentage rates since then.  Since early 2023, much of the new volume growth has come from so-called “0DTE” options, the daily expirations on key ETFs and especially the Cboe’s SPX index contract, which is cash settled.  Many speculators prefer this methodology, since no shares change hands after expiry – just money.

I attributed the first wave of growth to frustrated sports bettors during Covid.  Faithful readers know that this is a hypothesis I first raised as early as September 2020.  But even though I acknowledged that gambling analogies are rarely welcome at a serious options gathering, I got nervous immediately after making them.  It occurred to me that an SEC Commissioner spoke immediately before us and therefore was probably in the room.  I was relieved later on when another attendee said she happened to sit next to him and seemed to nod and smirk knowingly when I made the comment.

For those who have not previously seen my theory, these are the key points.  First, we had just legalized sports gambling throughout most of the country when sports shut down.  It meant that many more people had become familiar with that type of odds making.   Then, most of the country was working from home and many received stimulus checks.  People are far more likely to take risks with “found money” than with funds earned through their regular work.

Thus, newly minted options traders were quick to realize that the payoff structure on a call or put purchase is quite similar to that of a sports bet: it can offer a leveraged outcome with a defined initial outlay.

 Yet there three important additional benefits to options that new investors were also quick to implicitly realize:

1. Rather than one’s payoff being limited to the initial odds, it can potentially be unlimited
2. If enough players take the same side of a sports bet, it changes the odds but has no effect on how an honest contest is decided.  But if enough traders take the same side of the “bet” using options, it can favorably affect the outcome.  The “meme-stock” craze was an extreme example, but it became relatively normal to see hordes of options traders buying expiring weekly options on key stocks and ETFs on Friday afternoons, rolling them into higher strikes when the underlying shares rose, than attempting to do it again.  Sometimes they were successful several times
3. There are many more contests (contracts) on which to speculate.

It also forced many formerly smug professionals to realize an important fact: the so-called “dumb money is WAY smarter than the “smart money” gives it credit for being.  Individual investors recognized a good opportunities and took full advantage of them.

A key topic of conversations was Nasdaq’s filing for Monday and Wednesday expiring options on key single stocks.  That is a necessary first step toward daily expirations on those names.  The current crop of daily expiring, or “0DTE”, options started by listing Mondays and Wednesdays in addition to Fridays.  The industry generally views this development as inevitable. 

I never believed that the current 0DTE options create systemic risk, nor will these. They certainly could, however, introduce extra risks for unsuspecting traders – generally individuals.

Most people don’t realize that options don’t expire when the markets close at 4PM EDT but instead at 5:30. That means that if a move happens after the close, a holder can issue contrary instructions.  That means exercising options that seemed out of the money at the close or choosing to lapse those that seemed in the money.  This is among the rights that an option purchasers pay for and an obligation that an options writers take on in exchange for receiving a payment. 

The potential for contrary exercises means that someone who wrote expiring options and thought they were properly hedged could find themselves with a nasty, difficult to hedge, position.  It hasn’t been a major problem so far because most stocks don’t issue news on Friday afternoons.  Nor do the major indices that underlie 0DTE options typically have big post-close moves during the week.

But what if a company gives a profit warning after the close?  Or what if earnings in a related company cause another to move.  (How might Nvidia (NVDA) react if Broadcom (AVGO) earnings reveal something about industry demand?)  Someone with a seemingly riskless position could end up with a terrible one.  There were several discussions about how to mitigate those risks, but no consensus yet.  That will be a key topic of conversation for the options industry in the weeks to come and almost certainly be part of next year’s “state of the industry” discussion.

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