For most of Wednesday, it was a typical trading day on Wall Street and one poised to send U.S. stocks toward superlative finishes. That was until something upended the momentum within two hours of the closing bell.

Analysts say the cause, at least in part, for the steep and unexpected drop in the S&P 500 index
which occurred after 2 p.m. Eastern time, was linked to what’s known as zero-day to expiry options, or “0DTEs.” Such contracts have exploded in popularity since at least the beginning of 2023, and are being likened to lottery tickets for individual investors and to tactical protection for large funds.

The options are relatively cheap to purchase and give an investor the right, but not obligation, to buy or sell a stock or other asset at a given price before a certain expiration date. Contracts linked to the S&P 500 are usually settled in cash, meaning that investors with “in the money” positions can get cash payouts or sell them at profits.

Read: Here’s everything we know about zero-day options, the risky stock-market ‘lottery tickets’ captivating Wall Street and Reddit

In a post on X, formerly known as Twitter, SpotGamma, which analyzes the options market, described Wednesday’s stock-market pullback during the New York afternoon as an 0DTE-driven plunge in the S&P 500. A report by Bloomberg also cited traders as attributing the benchmark index’s decline to the zero-day options.

Prior to Wednesday afternoon’s sudden drop, the S&P 500 was close to its all-time closing high of 4,796.56, reached on Jan. 3, 2022. In addition, the Dow Jones Industrial Average
and Nasdaq Composite
seemed poised for a 10th straight day of gains.

Analysts said that overbought conditions and thin trading ahead of the year-end holiday season may have exacerbated the extent of the declines seen in all three indexes on Wednesday. The S&P 500 and Nasdaq each finished down by 1.5%, while the Dow Jones closed lower by 475.92 points, or 1.3%. The moves also snapped a nine-day win streak for the Dow Jones and Nasdaq.

Some disagreement remains, however, over what precisely triggered the stock market’s declines on that day.

Rocky Fishman, founder of derivatives analytical company Asym 500 in New York, said Wednesday’s daily 0DTE volume was the highest since early October, at $900 billion. But the options volume did not pick up until after a selloff in equities had already been under way — suggesting that investors as a whole were already in a bearish mood, Fishman said via phone on Thursday.

Meanwhile, Daniel Tenengauzer, a New York-based strategic adviser for the financial technology firm known as bondIT, said the broad-based stock selloff toward the end of Wednesday’s session coincided with the anticipated launch of an exchange-traded fund from ProShares that uses the short-dated “zero days to expiry” options on the S&P 500.

Each time an ETF linked to 0DTEs is launched, “the market starts to position for it” in the form of hedging or selling on the other side, Tenengauzer said. He likened the dynamic to the market setup ahead of a government-bond auction, where “you know there’s supply coming in and you need to make space for it” by selling ahead of time.

On Thursday, the stock market resumed its rally, with the S&P 500 inching back toward its record close again and the Dow Jones ending up by 322.35 points, or 0.9%.


Source link