The undying options boom

If you assumed that the end of the “Everything Rally” and life-shredding losses for extremely online trading bros would end the massive options boom then think again.

JPMorgan’s Nikolaos Panigirtzoglou and Peng Cheng have published a brace of reports this week that explore how the wild options phenomenon of 2020-21 has surprisingly held up in the 2022 bear market.

Although retail activity seems to have calmed down, it is notable how elevated things remain almost across the board — and a recent boom in zero-day options trading is raising eyebrows.

These charts show the average daily volume of US single-stock and index equity options. Individual option trading growth has calmed down from the wildness of 2020-21, but has edged up to a new record this year. And index option volumes have erupted.

How much do retail traders account for this? Less and less since the early 2021 frenzy, it seems, but retail option trading remains above pre-pandemic levels.

It’s impossible to know for certain what is retail or not, but most analysts have used smaller trades — for 10 contracts or less — as a decent proxy for what individual investors are doing as opposed to bigger institutions. It’s a flawed measure, given the rise of algorithmic trading means that even big hedge funds often slice up big trades into a seemingly-random blizzard of smaller ones, but it’s decent enough to make sense.

Here’s what JPMorgan found. Note that the chart below only shows estimated retail activity in single-stock options, not the index options.

Overall turnover of US equity options — both individual and index ones — has also fallen from the early-2021, but again has remained impressively/unnervingly resilient.

Broadly speaking, it looks like retail traders have calmed down a lot since 2021 but remain unexpectedly active in options, and financial institutions have more than picked up the slack — especially when it comes to index options.

But perhaps the most notable recent trend has been a jump in the share of zero-day options — puts and calls that expire the same day as they are written. There has been a general shift towards shorter-term options over the past three years due to the retail trading mania, but the rise in zero-day options is frankly astonishing.

Chang estimates that their share of overall S&P 500 index options has climbed from about 30 per cent at the start of the year to about 40 per cent today — and at times have accounted for almost half of all index options traded.

It would be easy to conclude that this is just a retail trading fad, but JPMorgan estimates that just 5.6 per cent of zero-day option trading volumes are because of retail investors — more than the 3.3 per cent average for the entire options market, but hardly the biggest driver.

Cheng and Panigirtzoglou reckon that the zero-day options flow has generally been a mildly stabilising force. Given that the flow has been biased towards option sellers, the dealers are generally more long gamma.

That means that they have to sell the underlying stock if the price rises, and buying it if the price decreases. But they stress that the gamma for zero-day options is generally less impactful than it is for longer-dated options.

They speculate that the increase might triggered by a rise in macroeconomic and financial uncertainty, which pushes investors into more short-term trades.

We belatedly saw that the FT’s Eric Platt and Nick Megaw has written a great piece on the phenomenon that quotes some traders and investors saying exactly this:

“Trying to predict where we’ll be in six months is a daunting task because [at the moment] every day feels like five days in itself,” said Brian Bost, the head of equity derivatives trading at Barclays. “Because the Fed is data-driven, it’s creating more front-loading of expression of views, because people are trying to navigate the next week or next couple of days.”

 . . . “If I have monthly options, I get 12 independent bets per year. If I have weekly I get 52 bets per year. Daily gives me 252. If you’re generating trading strategies, the ability to have more ‘at bats’ and more diversification by taking more independent trades can be useful,” said Roni Israelov, chief investment officer at wealth management firm NDVR and a former manager of options strategies at AQR.