Zero-Day-to-Expiry Options Trading and Variance Risk Premium: A Comprehensive Study Dissecting the Interplay between Ultra Short-term Expiration Option Trading and Underlying Variance Risk Premium

Omar Khalil

Studenteropgave: Kandidatafhandlinger

Abstract

Between the years 2011 and 2022, the financial derivatives market observed a substantial increase in the trading activities involving options that are set to expire on the same day of trade, commonly referred to as Zero-Day-to-Expiry (0DTE) options. This study explores the complex dynamics between 0DTE option trading and the variance risk premium (VRP) of the underlying asset. To dissect this relationship, the study utilizes an extensive dataset of options. The analysis involves synthesizing variance swaps to estimate the implied variance and calculating the daily realized variance to accurately determine the VRP. Employing both Ordinary Least Squares (OLS) and Instrumental Variable Two-Stage Least Squares (IV-2SLS) models to account for endogeneity issues, the research critically examines the impact of 0DTE trading developments on VRP. The findings reveal a pronounced inverse correlation between 0DTE option trading activity and VRP, implying a more negative VRP due to the heightened 0DTE trading. Strengthening the evidence in support of the hypothesis, this trend is partly driven by the introduction of a more granular array of option expirations by market vendors, which allows traders to hedge against intraday macroeconomic events or speculate on intraday volatility with leveraged lottery-like payoffs. These insights offer valuable implications for understanding market behaviors in the face of evolving trading practices.

UddannelserCand.merc.oecon Advanced Economics and Finance, (Kandidatuddannelse) Afsluttende afhandling
SprogEngelsk
Udgivelsesdato15 jan. 2024
Antal sider104
VejledereAnders Bjerre Trolle