Debt Ceiling Optimism Or Just 0-DTE Degeneracy

Bloomberg reported, "US Stocks Climb on Debt Deal Hopes," claiming that worries over the debt ceiling started to fade away. In case you're wondering what the "debt ceiling" is, it's like the country's credit card limit.

More info about the debt ceiling in my previous posts:

However, a lot of financial analysts on FinTwit (Basically, that dark corner of Twitter for finance nerds) claim the stock market isn't rising due to the debt ceiling fears fading away but actually due to increased activity in something called 0-DTE options trading.

0-DTE stands for "zero days till expiration". To really oversimplify it, 0-DTE options are like betting on the stock market equivalent of a horse race that's about to finish. They're contracts that you can buy and sell on the same day they expire.

With these 0-DTE options, you can make a lot of money from small price changes that happen throughout the day without having your bet open overnight. But it's not like playing with fire necessarily since your loss is limited if you buy them.

However, these 0-DTE options can swing wildly in value, and the option contract can lose value all of its value within 1 day as time passes (that's the "Theta decay" part).

For more information about options, I wrote a series of articles: https://medium.com/@romanornr/list/options-trading-fce6d05f0412

To play this degenerate game, you need to have a lot of trading experience, a hefty bankroll, lightning-fast decision-making, and action-taking skills. This type of trading can shake up the underlying assets' price (In such cases, Nvidia, Tesla, MSFT, etc.) because everyone's rushing to close out their position before the expiration time hits.    

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CDS?

Some on Twitter started comparing 0-DTE option trading to Credit Default Swaps (CDS), especially how they were used before the Global Financial Crisis in 2008.

Before the global financial crisis (GFC) of 2008-2009, CDS were widely used to generate income and hedge risk. Kind of like selling OTM 0-DTE calls to generate "passive income"

Before the 2008 global financial crisis, these Credit Default Swaps were used like lottery tickets too. Betting whether borrowers would be able to pay back their debt or default on their loans. This market got really big and became a giant betting pool.

So when the housing bubble burst, this created an enormous problem. All these bets that were placed increased the damage when things went south.

It was like adding fuel to the fire, amplifying the systemic risk. It was one of the factors that led to the big financial crisis in 2008. Now analysts are worried we might be trading in similar territory with 0-DTE options. Well, in this case, right now, it made prices go up.

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Which explanation is right?

In a way, 0-DTE options trading is kind of like betting on the small ripples in a pond rather than the overall size of the pond itself. It's not really about what the Nasdaq (the pond) is actually worth but more about the small ups and downs (the ripples) that happen because of all the noise and chaos in the market.

The problem is this can create a vicious cycle that messes with how prices are normally figured out or priced, and it can make the whole market a lot shakier. The institutions selling these 0-DTE option contracts are taking a massive risk. Remember Gamestop and AMC? The Gamma Squeeze.

So while Bloomberg's shitpost about the stock market going up due to fading fears about the debt ceiling sounds nicer to investors who are rooting for prices to go up.

According to the Dutch Rabobank, FinTwit argument seems a bit more realistic & yet worrying.  0-DTE options trading isn't really a dependable engine for market growth. It's more a sign of people taking way too much risk and speculating too much, which can backfire at some point. The loss of 0-DTE option buyers is limited, but we know how it works. Your bet may didn't work today, but you can bet that you will bet again tomorrow and the day after.

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