0DTE Options in DeFi

Zero Days to Expiration (0DTE) options are contracts that expire on the same day they are traded, offering traders a unique opportunity to make quick profits or hedge positions within a single trading day. 

Unlike traditional options, which can have expiration dates ranging from months to days, 0DTE options expire within hours. These fast-paced instruments are relatively new, having only been traded since 2022, but they have rapidly gained popularity. According to the Financial Industry Regulatory Authority (FINRA), between January 2022 and 2023, the number of opening 0DTE options positions increased by approximately 60%, with retail customers seeing an even higher increase of about 75%.

Unfamiliar with trading options? Check out our Intro to Options series.

0DTE Options and DeFi: A Natural Fit

In the world of decentralized finance (DeFi), the market never sleeps, the trading never stops, and digital assets are known for their high volatility. This continuous and volatile environment creates unique challenges for financial instruments that are designed to manage risk and seize opportunities. While options trading is well-established in traditional finance, it hasn’t yet gained the same traction in DeFi. However, 0DTE options, with their unique risk profile, align more closely with the high-risk, high-reward appetite of cryptocurrency traders.

Here’s why 0DTE options are an excellent fit for digital assets like ETH, BTC or perhaps even your favorite memecoin:

Speculative Opportunities

The combination of high volatility and the short lifespan of 0DTE options creates numerous speculative opportunities for traders looking to make quick profits.

Volatility Management

Cryptocurrencies often experience rapid price movements within short periods. 0DTE options allow traders to capitalize on these movements or hedge against them without committing to longer-term contracts.

Flexible and Responsive

With options with expirations as short as 4 hours, traders can use 0DTE options to respond quickly to news, events, or sudden market changes, which are common in crypto. This flexibility is particularly valuable in a market where sentiment can shift rapidly. Additionally, a short duration allows for users to trade against coins that tend to have much shorter life cycles.

Liquidity

The high demand and active trading in the crypto market provide the necessary liquidity for 0DTE options, enabling smooth entry and exit for traders.

Moreover, the shorter expiration of 0DTE options results in shorter commitments for underwriters and market makers. This often leads to lower premiums, making these options a cost-efficient way to hedge or gain exposure to assets like ETH, BTC, or other coins. Longer-term options typically carry higher premiums because they offer more time for the market to potentially move in the buyer’s favor, whereas 0DTE options provide a cheaper, more immediate alternative.

Why 0DTE options are attractive to underwriters

The appeal of 0DTE options extends beyond traders—they also possess qualities which are highly attractive to underwriters for several key reasons:

Reduced Exposure Time

Underwriters benefit from the reduced exposure time associated with 0DTE options. Since these options expire within hours, the risk of market movements negatively impacting their position over time is minimized. This short duration allows underwriters to quickly assess and manage their risk.

Efficient Capital Use

The short lifespan of 0DTE options allows underwriters to recycle their capital more frequently. Instead of tying up capital in longer-term options, underwriters can deploy it multiple times in a day, potentially increasing their overall returns. Users that underwrite options can roll into positions every 4 hours and more quickly adapt to market volatility (rather than locking up until expiration that could be weeks or months away).

Market Making and Liquidity Provision

For underwriters who also act as market makers, 0DTE options contribute to the liquidity of the market. By providing continuous quotes and managing the flow of buy and sell orders, underwriters can earn a spread while supporting the overall efficiency and fluidity of the market.

Ease of Bootstrapping 0DTE Options

Bootstrapping a market for 0DTE options is also easier compared to longer expiration options. Here’s why:

Lower Initial Complexity

Bootstrapping 0DTE options requires less upfront complexity compared to longer expiration options. With their short duration, the models and infrastructure needed to price and manage these options are simpler and more focused on immediate market conditions rather than long-term forecasts. Traders may find this simplicity to be more approachable.

Minimal Need for Long-Term Data

Longer expiration options often require extensive historical data and complex models to predict long-term volatility and price movements. In contrast, 0DTE options rely more on real-time data and short-term trends, making it easier to launch these products without the need for extensive data aggregation and analysis. In other words, there may be less requirements for launching 0DTE options for tokens and popular memecoins.

Faster Market Feedback

Since 0DTE options expire the same day, underwriters and market participants receive almost immediate feedback on pricing models, demand, and market dynamics. This rapid feedback loop allows for quick adjustments and optimization, which can be crucial in the early stages of launching a new options market.

Attracting Speculative Traders

The speculative nature of 0DTE options, combined with the high volatility of cryptocurrencies, can attract a large number of traders looking for quick profits. This influx of traders can help bootstrap the market, providing liquidity and volume that can support the growth of the options market.

Optimal for Guarded Launches

For protocols like Scholes, 0DTE options offer a compelling strategy for a guarded launch and an opportunity to accelerate the bootstrapping process. Due to their short duration, 0DTE options can start with higher collateral requirements which can then be reduced each cycle. This simplifies risk management for the initial launch of the protocol and makes it easier to establish new option pools. The increased pace and volume of option trading may generate fees faster, helping to build the protocol’s backstop more quickly.

Conclusion

Options trading introduces a unique blend of opportunities and challenges to the DeFi ecosystem. For traders, 0DTE options offer a powerful tool to navigate the inherent volatility of digital assets, enabling quick responses to market shifts and seizing short-term speculative opportunities. Meanwhile, for underwriters, these options present a chance for more efficient capital utilization, reduced long-term exposure, and a streamlined approach to market entry. 

0DTE options much like crypto are fairly new to the world of finance and both are poised to play a pivotal role in enhancing both trading strategies and market infrastructure. 0DTE options are likely to become an increasingly important tool for both traders and market makers, contributing to the ongoing development and sophistication of decentralized finance.

There’s never been a better time to begin learning. It’s only natural that early DeFi pioneers, such as yourself, will be the ones to capitalize on the birth of 0DTE options. If you start now, you can say you traded 0DTE options in the first 5 years of their existence. 

The Scholes community is blazing the trail of 0DTE options together. You’ve made it this far… Seize the opportunity today to reap the rewards of tomorrow. The trail we blaze together leads to a future where anyone can create a thriving market for any token, from spot to derivative markets.

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