Equity market volatility (VIX) has been surprisingly low in 2023 despite uncertainty about interest rates and geopolitics. Some attribute this to the rise of short-term “zero-days-to-expiry” (0DTE) options trading. However, a recent article by the BIS argues that 0DTE trading is unlikely to be the main cause for low VIX and provides an alternative explanation: increased hedging activity by dealers selling structured products to investors.
Key Points:
- 0DTE Options: These options are cheap, lottery-like instruments with high leverage and extreme potential returns (both positive and negative). Their trading volume has increased significantly.
- VIX Relationship: While 0DTEs have grown, they aren’t a major driver of VIX due to their short expiry and the fact that VIX is calculated on one-month options.
- Structured Products: The rise of yield-enhancing structured products (like covered calls) is a more likely explanation for compressed volatility. Dealers selling these products hedge their risk by buying when the market falls and selling when it rises, dampening price movements and lowering volatility.
Read their analysis here.
