0DTE Option Pricing

53 Pages Posted: 16 Jul 2023 Last revised: 20 Feb 2024

See all articles by Federico M. Bandi

Federico M. Bandi

Johns Hopkins University

Nicola Fusari

Johns Hopkins University - Carey Business School

Roberto Renò

ESSEC Business School

Date Written: July 7, 2023

Abstract

The market for ultra short-tenor (zero days-to-expiry or 0DTE) options has grown exponen- tially over the last few years. In 2023, daily volume in 0DTEs reached over 45% of overall daily option volume. After briefly describing this exploding new market, we present a novel pricing formula designed to capture the shape of the 0DTE implied volatility surface. Pricing hinges on an Edgeworth-like expansion of the conditional characteristic function of the continuous portion of the underlying’s price process. The expansion shifts probability mass from an oth- erwise locally Gaussian return density by adding time-varying skewness (through leverage) and time-varying kurtosis (through the volatility-of-volatility). The expansion is local in time and, therefore, naturally suited to price ultra short-tenor instruments, like 0DTEs. We document considerable (1) price and (2) hedging improvements as compared to state-of-the-art specifica- tions. We conclude by providing suggestive results on nearly instantaneous predictability by estimating 0DTE-based return/variance risk premia.

Keywords: Ultra short-tenor options, zero days-to-expiry options (0DTEs), pricing, instantaneous return/variance risk premia

JEL Classification: C51, C52, G12, G13.

Suggested Citation

Bandi, Federico M. and Fusari, Nicola and Renò, Roberto, 0DTE Option Pricing (July 7, 2023). ESSEC Business School Research Paper No. 2023-03, Available at SSRN: https://ssrn.com/abstract=4503344 or http://dx.doi.org/10.2139/ssrn.4503344

Federico M. Bandi

Johns Hopkins University ( email )

100 International Drive
Baltimore, MD 21202
United States

Nicola Fusari (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Roberto Renò

ESSEC Business School ( email )

3 Avenue Bernard Hirsch
CS 50105 CERGY
CERGY, CERGY PONTOISE CEDEX 95021
France

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