What are zero day to expiry options (0DTE)

Understanding zero day to expiry options (0DTE)

Definition of zero day to expiry options (0DTE)

Zero day to expiry options (0DTE) are options contracts that expire at the end of the current trading day. Once the market closes, the option either becomes worthless or is automatically exercised. Every options contract, whether it was issued a month ago or a week ago, eventually becomes a 0DTE option on its expiration date.

The main idea behind trading 0DTE options is to collect profit from the rapid decay in the premium by selling these options contracts and buying them back at a lower price later in the day. Because they only exist for a single trading day, 0DTE options are fast moving and experience significant price movements before they expire. This creates the potential for quick profits as well as losses.

Reasons why 0DTE options are popular

So, what’s the appeal of trading contracts with such a short lifespan? Some reasons why 0DTE options are popular include:

• No overnight risk: Positions automatically close at the end of the day, so traders don’t have to worry about overnight market swings
• Lower premiums: Because time value is minimal, 0DTE options often cost less than longer-dated contracts (i.e. premiums can be in cents versus dollars)
• High leverage: They offer high leverage, so small investments offer significant exposure to the underlying asset
• Tight bid-ask spreads: 0DTE options are usually traded on assets that have high liquidity, so they often have tighter spreads, which means lower trading costs.

Identifying 0DTE options trading strategies

0DTE options can be traded using the same strategies as regular weekly or monthly options. But with a reduced time to expiration, traders often focus on strategies designed to capture rapid price movements or short-term fluctuations.

Some common 0DTE options trading strategies include:

Single option strategies

A single options strategy involves buying or selling a single call or put option without owning the underlying security or using a spread to hedge. Traders buying 0DTE calls or puts hope for sharp intraday moves and have limited downside (equal to the premium paid). Sellers hope the option expires worthless so they can keep the premium, although this carries much higher risk – especially with uncovered (naked) calls, which have unlimited loss potential.

These trades are simple to execute, but with limited time to recover from a bad move, both buyers and sellers need to manage risk carefully.

Covered calls

Covered calls involve traders selling a 0DTE call option against shares they already own. This allows them to generate income from the premium received. If the stock closes below the strike price, the call expires worthless and the trader keeps the premium. If it closes above, they can sell the stock at the strike price, although this can limit potential upside if the stock price rises significantly.

Vertical spreads

Vertical spreads involve buying and selling options of the same type (either two calls or two puts) with the same expiration day but different strike prices (e.g. bull call spreads, bear put spreads, bull put spreads, or bear call spreads). These setups can help traders manage their risk while potentially benefiting from bullish or bearish moves in the underlying asset.

Cash-secured puts

In a cash-secured put strategy, traders sell a 0DTE put option while holding enough cash to buy the underlying stock if the short put is assigned. Like covered calls, cash-secured puts allow traders to generate income from the option premium, however they also offer the opportunity to buy the stock at a discount if it closes below the strike price.

Iron condors

An iron condor is a neutral strategy that profits if the underlying stock stays within a defined range. It involves simultaneously selling an out-of-the-money call spread and an out-of-the-money put spread on the same underlying. If the asset stays between the strike prices at expiration, the trader keeps the premium and losses are capped to the width of the widest spread.

Straddles and strangles

Straddles and strangles are often used when traders expect substantial moves in the underlying asset but aren't sure in which direction. If they expect large moves, they can trade a long straddle/strangle. If they expect the asset to move sideways, they can trade a short straddle/strangle. Note that potential losses can be substantial if the stock price rises or falls, and risks are especially high for short positions that are uncovered.

Analyzing the risks of 0DTE options

0DTE options offer the potential for fast profits, but because they expire at the end of the same trading day, there’s very little room for error. It’s essential for traders to understand the risks involved with these options and how to mitigate them before they begin trading. Let’s look at some of the risks of 0DTE options below.

Market volatility

Market volatility can work both for and against a 0DTE trade. Since there’s limited time to expiration, even small price swings in the underlying asset can cause sharp movements in the option’s value. This can lead to both significant gains and losses.

Volatility tends to increase around key events like economic data releases, Fed statements, or earnings announcements, which options traders look to potentially capitalize on. But if the market swings in the wrong direction, or if there are surprising moves late in the day, a position can turn negative quickly.

For example, on July 11, 2023, the SPX traded sideways most of the day. Then, in the final minutes, a surprise rally triggered a short squeeze that wiped out many short positions. This kind of shift can be devastating for 0DTE option sellers caught on the wrong side of the move.

Time decay (Theta)

Time decay moves ultra fast for 0DTE options, with Theta representing how much an option’s price erodes with the passage of time. On the final day, this decay accelerates by the hour. If the underlying asset doesn’t move enough, long options can lose their entire value in a matter of hours (or even minutes).

Even normal-sized moves can have a massive impact on the option’s price, which is why 0DTE options can be so attractive to buyers. However, it’s easy for buyers to overestimate the chances of a big move and options buyers risk losing all of the premiums paid on the options.

Liquidity risks

0DTE options can be very liquid, especially for major indexes like SPX or ETFs like QQQ and SPY, but it’s not the case for all options. Less popular symbols or strike prices can have lower volumes and wider bid-ask spreads, making it harder to enter or exit a trade at a good price.

This is especially important when markets move quickly. Wider spreads or a lack of buyers and sellers can lead to slippage, where you’re forced to accept a worse price than expected. To manage liquidity risk, it’s best to stick to high-volume tickers and avoid trading too close to market close unless you’re fully prepared.

Limited time to adjust

With longer-dated options, traders have time to recover from a bad move, adjust their position, or hedge against losses. This opportunity barely exists for 0DTE contracts. Once you’re in a trade, there’s little flexibility to wait out a move or roll a position into the next day. You need to make quick decisions under pressure, which can sometimes lead to losses or missed opportunities. This is why it’s especially important to have a clear entry and exit plan, and stick to it.

Trading options involves significant risk and is not suitable for all investors. Options strategies can be complex and may expose investors to substantial losses. These products are generally intended for more experienced traders who have advanced knowledge of financial markets, trading strategies, and risk management. Before trading options, clients should carefully consider their investment objectives, financial situation, level of experience, and risk tolerance.

Trade 0DTE options

How to trade 0DTE options

Now that we’ve covered the basics of 0DTE options and their risks and strategies, let’s look at how you can start trading them.

Step 1: Open and fund an options-approved brokerage account

The first step is to open a brokerage account that’s approved for options trading. Some things to look for are a broker that offers margin and the necessary tools and features to trade 0DTE options, like charting tools, screeners, and options calculators. Since trading 0DTE contracts requires making frequent transactions, it’s also worth finding a broker with low commission costs and fast execution speeds to limit trading costs.

When setting up your account, you may need to answer some questions about your trading experience, financial background, and risk tolerance. Some brokers might even ask you to complete an online course to demonstrate your knowledge of options trading. Once you’ve been approved, you can fund your account with enough capital to execute your desired trades.

Step 2: Choose the right underlying and expiration

0DTE options are typically available on highly liquid products like the S&P 500 Index (SPX), SPY, QQQ, or NDX. These products offer tighter bid-ask spreads and active markets, both of which are important for short-term trading.

When choosing an underlying, make sure it aligns with your investment strategy, analysis, and risk profile.

Step 3: Conduct market analysis

Next, conduct market analysis to identify potential short-term price movements. This could include technical analysis, fundamental analysis, or both. Have a plan for how the underlying is likely to behave and how your trade will respond.

Step 4: Determine position size

Now you can decide the right position size based on how much capital you’re willing to put at risk. Things to consider at this stage are maximum risk per trade, risk-reward ratio, and available risk capital. Many traders like to risk no more than 1-2% of their total capital balance per trade.

Step 5: Place the trade

You can now use your brokerage platform to place orders to buy or sell 0DTE contracts based on your chosen strategy and analysis. Different types of orders include market orders (executed immediately), limit orders (execute only if the option reaches a specified price), or stop orders (automatically exits the trade if the market moves against you).

Step 6: Monitor your position

Once the trade is active, make sure to keep a close eye on intraday price movements and market conditions. Be prepared to adjust, close, or hedge your position if the market shifts unexpectedly. Remember, the window for decision-making is short with 0DTE, so you need to stay focused.

Step 7: Exit your trade

Make sure to have a clear exit plan before you enter the trade to lock in profits and minimize losses. For example, you might want to exit once you reach a specific price target, technical indicator signal, or time period.