Abstract: The market for ultra short-tenor (zero days-to-expiry or 0DTE) options has grown exponentially over the last few years. In 2023, daily volume in 0DTEs reached over 45% of overall daily option volume. After briefly describing this exploding new market, we present a novel pricing formula designed to capture the shape of the 0DTE implied volatility surface. Pricing hinges on an Edgeworth-like expansion of the conditional characteristic function of the continuous portion of the underlying's price process. The expansion shifts probability mass from an otherwise locally Gaussian return density by adding time-varying skewness (through leverage) and time-varying kurtosis (through the volatility-of-volatility). The expansion is local in time and, therefore, naturally suited to price ultra short-tenor instruments, like 0DTEs. We document considerable (1) price and (2) hedging improvements as compared to state-of-the-art specifications. We conclude by providing suggestive results on nearly instantaneous predictability by estimating 0DTE-based return/variance risk premia.
Abstract: I show that non-linear pricing of market risk can explain many prominent cross-sectional stock return anomalies, such as momentum, betting-against-beta, idiosyncratic volatility, and liquidity. The non-linear pricing model is inferred from options data without assumptions on the pricing relationship. I further document that many anomalies have a strong tail risk exposure, which is successfully priced by the model. A key feature of the model is a sizable upside risk premium of approximately 4% per annum. Finally, the pricing results can be explained with a compensation for exposure to systematic variance risk.
Discussant: Dmitriy Muravyev, Michigan State University
Grigory Vilkov, Frankfurt School of Finance and Management
Abstract: Trading in short-term, especially same-day expiry (0DTE), options has recently surged, raising concerns about its possible destabilizing impact on the underlying market. Given the inverse relationship between time to expiration and gamma, measuring delta-hedging intensity, sizeable open interest in short-term options can extend volatility following large market moves. We document that contrary to the intuition that mainly option sellers delta-hedge (that would aggravate market moves), high open interest gamma in the morning does not propagate past volatility. Instead, it is typically associated with lower intraday volatility, indicating that option sellers anticipate volatility or that delta-hedging flows are largely balanced on either side of the open interest. We document high volatility and positive skewness of realized 0DTE straddle returns; 0DTEs realized variance risk premium is exceptionally high, especially after resolution of uncertainty episodes, such as Federal Open Market Committee announcements.
Discussant: Neil Pearson, University of Illinois-Urbana-Champaign
