NEW YORK, Aug 7 (Reuters) - Investors avoided trendy short-dated equity options and looked to longer-tenor contracts for protection during a meltdown in U.S. stock earlier this week, exposing the limitations of so-called 0DTE options in guarding against sustained market gyrations, data showed.
Traders have flocked to S&P 500 contracts with zero days to expiry - known as 0DTE contracts - since their 2022 launch, with the category sometimes accounting for more than half of daily S&P 500 options volume.
While the contracts are often thought of as vehicles for traders to speculate on short-term market moves, they are also used by institutions and retail investors to protect against market volatility.
Investors, however, spurned the contracts on Monday, when the S&P 500 sank 3% and the Cboe Volatility Index (.VIX), logged its largest intraday jump before closing at a four-year high. 0DTE options' share of total S&P 500 options volume fell to 26%, down from its average share of 48% this year, according to data from OptionMetrics.
"What we've seen here is a shift from short-term hedges to people saying, 'oh, my gosh, I need something longer dated'," said Jim Carroll, portfolio manager at Ballast Rock Private Wealth.
Analysts pegged the move on a variety of factors. The surge in volatility caused options dealers to price 0DTE contracts at sky-high levels to manage their own risk. That raised the appeal of longer-term contracts, which, while also pricey during the selloff, were more palatable to investors since the protection they afford is more lasting, market participants said.
"The market seemed unable to price these options at such high levels of volatility," said Garrett DeSimone, head of quantitative research at OptionMetrics. "This would also explain the absence of volume.”
Volume in the short-dated contracts rebounded to about 42% the day following the selloff, as markets calmed, data from Trade Alert showed.
In the throes of the selloff, investors fearful that the volatility surge would be sustained saw little value in holding short-term contracts, said Craig Peterson, CEO of options research firm Tier 1 Alpha.
On Monday, 0DTE options volume was 26% lower than the same day a month ago, while non-0DTE options volume jumped 42%, OptionMetrics data showed.
"It's difficult to hedge longer-term risk with a one-day option,” Peterson said. “I think that's what's really been driving people back into those longer-dated tenors."
Reporting by Saqib Iqbal Ahmed; Additional reporting by Laura Matthews Editing by Marguerita Choy
