Lewis Taie, Senior Manager, Derivatives Program AUSIEX

Internationally we’ve seen great success in the growth of derivatives market volumes largely driven by activity in short-dated series referred to as Zero Day options. The CME Group in particular have seen significant growth in the average daily volume of these listed derivatives, with their E-mini NASDAQ contracts up around 80% from 2023 vs 2022 and E-mini S&P 500 options up 19% over the same period.  

Domestically, we’ve already seen successful listing of shorter dated securities (in weekly options) and successful uptake with the traded volume of weekly options making up 30% of all ASX 200 XJO volume and 12% of single stock option volume.

On the Zero Day options front, we’ve lagged the US in their developments which arguably provides the advantage of learning from our international counterparts to replicate their success while learning from any difficulties faced. As such, the purpose of this article is to address how Zero Day options may work within the Australian markets, along with any required changes to have the best chance replicating international success.

Before digging into Zero Day options and how they may fit into the Australian market, it’s important to keep in mind a few key characteristics as well as to address a common misconception around the operation of these instruments.

At their most fundamental level, a Zero Day option is simply an option that, as it sounds has zero days to expiry. i.e. the option will expire on the current trading day. The short-dated nature of these series provides timely exposure for investors looking to trade potentially high volatility events such as central bank decisions or company earnings announcements.

As highlighted, there is however a common misconception around Zero Day options, in that they need to be listed on the morning of expiry. While Zero Day options can be listed on the day of expiry, on both the NYSE and CME these securities are not listed on the morning of expiry, but rather are listed on a daily basis, with a 1-week expiry. Under this structure existing listing conventions are maintained while also ensuring an options contract will expire each trading day.

i.e. On Tuesday morning new options series are listed to expire the following Monday.

This begs the first question regarding Zero Day options in the Australian market. Should Zero Day options be listed a week in advance on a daily basis, or be listed at the beginning of each trading day to expire at the close?

There are benefits to each approach for different industry stakeholders.

Benefits of being listed a week in advance on a daily basis

1. Listing weekly options daily is an established procedure and would be less likely to require review of Design and Distribution frameworks.

Under the current Design and Distribution Obligations, brokers providing access to retail clients (that are either self-directed or receiving general advice) must ensure that the client falls within their target market determination (TMD).

By introducing new conventions with Zero Day options to list and expire the same day, regulators may require product issuers review and amend their TMDs to incorporate these securities, ultimately impacting broker distribution. Should these securities take on existing listing conventions of weekly options we view the continuity as being less likely to require regulatory review, improving uptake.

2. Incremental rollout, listing one day at a time to gauge demand

By listing series a week in advance, an incremental approach can be taken to the rollout to better gauge demand. Should we see significant interest in a newly listed Tuesday expiry, the rollout of further Monday, Wednesday and Friday contracts can be more appropriately managed by the exchange. This significantly simplifies the rollout, reducing the unnecessary expenditure from the exchange that an ‘All or nothing’ approach that a daily list and expire model would require.

3. Greater range of use cases vs contract expiring same day

Listing a week in advance increases the number of use cases and strategies these series may be used in. A 2 to 4 day expiry enables investors to take advantage of the most rapid pace of time decay. This can allow investors to construct short-dated calendar spreads coming into company earning announcements or central rate decisions opposed to simply taking a single day view if listed to expire same day.

Benefits of being listed at the beginning of each trading day to expire at the close

1. Reduced load on market makers and exchanges attributable to less series listed concurrently.

While we often consider the introduction of new securities or exchange traded derivatives from the point of view of a liquidity taker, it’s equally important to consider the requirements on liquidity providers like market makers. With this context in mind, it’s important to consider whether an increase in the number of listed series that listing Monday, Tuesday, Wednesday and Friday contracts would result in, and whether it would impact the bandwidth of market makers and their ability to price effectively.

2. Greater utility to traders from an end of day reference price

When assessing the reference price that should be used (opening or closing price), arguably investors looking for intraday exposure would derive a greater benefit from a position expiring at end of day opposed to the opening, while investors looking for exposure across days would have less of a preference as they would be more focused on an outcome across a number of trading sessions.

With this in mind, AUSIEX makes the argument for a closing reference price to be used across all underlying. This would require no change for single stock options, though would differ from the current approach for index options. Currently for ASX 200 index options, the expiry convention uses the Opening Price Index Calculation (OPIC) in order to determine the final cash settlement amount of each contract.

The introduction of daily expiries with different reference price mechanisms to currently listed Thursday expiries would need to be managed by the exchange, though could be aligned to use the closing price in time, should uptake of daily contracts warrant permanent adoption.

So what does success in the Australian market look like?

With the benefits of each listing convention the question becomes, for Zero Day options to succeed in Australia, what is the ideal structure for listing?

Listed a week in advance on a daily basis, or be listed to expire same day?

Given the items discussed, AUSIEX sees the greatest likelihood for successful uptake of Zero Day options where series are listed a week in advance on an ongoing basis.

We view this as the most streamline approach for an exchange to rollout on an incremental basis, least likely to warrant regulatory review impacting distribution, simplest for investors to wrap their heads around as well as providing the greatest utility to investors employing the widest range of strategies possible. All of which provides the greatest likelihood of success and hopefully driving the next phase of growth in Australian Equity Derivatives markets.