Basic Points

• Zero DTE refers to trading (or analyzing) options on their last day of expiration (opex). 
• DTE means days to expiration, and so “zero DTE options” are simply options on their last day before either expiring worthless or with some value. 
• Zero DTE options have extremely high gamma levels (how quickly the directional exposure of an option changes based upon success with direction) and extremely high theta levels (the accelerating pace of the time decay of an option’s price). 
• As long as most institutional players are short zero DTE options, then this has a stabilizing effect for the market during the day; overnight gaps lack this liquidity protection, with liquidity meaning enough bids and offers available to keep prices stable. 

Intermediate: Using HIRO to Analyze Zero DTE Option Flow

Our Alpha members have access to HIRO, which shows the hidden real-time zero DTE option flows each day. This is pictured here below with SPX as an example (representing the S&P 500 index).

These zero DTE options can also be broken down into puts vs calls if you opt for that in the settings.

This information from HIRO is model-free data and a passive gauge of information. There is no guesswork because the metadata from the data vendor has signatures showing which contracts hit the ask (buyers) and which contracts hit the bid (sellers). What we then measure for you is the running total of delta, which shows how bullish or bearish the flow is. This is not volume and has nothing to do with volume. It is just delta (directional exposure). 

Advanced: Zero DTE and Market Gamma

As of 2022, zero DTE trading has taken center stage in the discussion. Institutions and retail volume alike have flowed out of longer-dated contracts and into ultra-short duration contracts with single-digit days to expiration. Given that gamma (acceleration of directional exposure) becomes stronger approaching expiration, the rise of zero DTE means that more volume (the total shares being traded) is now using more gamma.

If this zero DTE volume becomes too extreme, then it can be especially destabilizing for the market if aggressors (those buying at or above the ask or selling at or below the bid) are mostly long zero DTE options. This is because that makes dealers short those same zero DTE options, and this is the period where being short gamma (from being short options) is as dangerous as it gets, prompting violently large market orders (from market makers) in the direction of the underlying security’s trend. 

In other terms, this means that if aggressors are mostly short DTE options (and dealers are long), then this adds strongly positive market gamma. For the most part, this can effectively keep prices contained in a relatively small range. 

Expert: Zero DTE and Volatility

Below is proof of how much zero DTE has affected the nature of the volatility surface (time and strike/delta each on their own independent horizontal axis vs IV% on log scale vertically), with comparisons below of 2023 in blue to 2022 in orange. Log scale is used so that there can be infinite room for the expansion of volatility–to make room for how volatility can technically expand infinitely.  

<3D volatility surface retrieved from Trader Workstation>

The above visualization of the 3D surface is what it looks like with all the volatility smiles connected from each day, showing that skew.

The volatility surface of SPY is almost identical to how it was at this time last year (mid March of 2022). Even the strike placements are lined up the same. The big difference however is what is happening in the zero DTE segment, in which case we can see spiked IV (implied volatility) at-the-money and also out-of-the-money on the put side.

This is the new arena we are in. As a refresher on the mechanics, this extreme IV is partially offset by how a smaller and smaller slice of vega is part of the equation for how options are priced as they approach expiration. This means that IV is higher (which raises the price of options). 

However, this extreme IV on the last days of expiration, as shown on the surface, is merely amplifying an ever-smaller area of the pie chart on what makes up the price of the option. This is the tradeoff. 

On the other end of the term structure (IV compared to time), longer-dated options have larger and larger slices of vega, which means that their prices are more sensitive to changes in IV.

It follows that, with zero DTE options, they have the smallest amount of vega, which is the part of the price that gets amplified by IV. Eventually, this slice is worth zero at the contract’s actual expiration because there is only intrinsic value left (how much the spot underlying price outperformed the strike price minus the debit paid to buy the option). This dynamic of the vanishing slice of the option’s value (amplified by IV) must be considered when trying to trade volatility on zero DTE options.