The VIX Is Dead, Long Live The 0DTE VIX

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by Tyler Durden
Friday, Apr 21, 2023 - 03:27 PM

Authored by Simon White, Bloomberg macro strategist,

Trading in zero-day-to-expiry contracts continues to dominate the options market, leaving the VIX unreflective of underlying market risks. 

Since the VIX is calculated using derivatives that expire 23 to 27 days into the future, the thinking is that it has been struggling to capture this near-term sentiment, which largely emerged last year when the introduction of new expiration days fomented the boom.

Put simply: In the age of 0DTE, Wall Street may need a new fear gauge.

Enter the one-day VIX.

“This makes sense because so much of the volume has moved to shorter tenors,” said Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets.

“I’ve been joking that the VIX is going through a mid-life crisis, being replaced by someone younger (shorter dates).”

Next week, the CBOE will launch a One-Day VIX that will give market watchers a much fuller picture of risks in the equity market.

For those who don’t want to wait that long, here’s a back-of-the-envelope calculation of just how much more risk traders see in the market than captured by the conventional method.

We’ll have to make some simplifications, and this isn’t a means of front-running the CBOE 1-Day Volatility Index.

We’re only using ATM options, so this doesn’t include any information on skew, but it shows the overall picture: ~0DTE vol has been structurally rising versus the VIX.

Following only the VIX in recent months would be like watching a duck serenely swimming on a pond, unaware of the “zero-day” legs frantically swimming under the water.

A glance at MOSO (Most Active Options Page on Bloomberg) shows that very often the top-traded option contracts expire that day.

There is ongoing debate in markets whether these duck legs are inherently destabilizing. No margin needs to be posted for zero-day options, so it is easy to increase leverage.

Overnight risk has probably increased as 0DTEs are being used to hedge.

Also, risk-taking will likely rise to maintain profitability as more people start executing similar 0DTE strategies.

So while 0DTE trading may not be an immediate market risk, there are enough concerns to make it essential to add the one-day VIX to your screens next week.