The Truth About 0DTE Options Time Decay

In options trading, the concept of time decay—or theta—is a well-understood phenomenon, particularly over longer durations. Most traders who sell premium (option sellers) specifically target entries and exits to take advantage of the traditional time decay curve. 

For example, a trader might sell an option spread 30 days from expiration and try to profit from the accelerating time decay as the contract nears expiration. When dealing with 0DTE (zero days to expiration) options, however, this theta decay occurs within the span of a single trading day.

Naturally, with the growing popularity of 0DTE options, traders are flocking to 0DTE options assuming quick decay means quick money. But how fast is fast? And when should you enter the market on expiration day if your goal is to profit from time decay?

For the retail trader, understanding this accelerated decay curve is crucial, as it determines the viability of strategies that rely on the rapid deterioration of option premiums. 

This article delves into the specific behavior of 0DTE options, with a focus on the SPX index. We'll explore the unique decay curve characteristics, analyze empirical data, and discuss the implications for traders.

Methodology

To accurately capture the decay curve of 0DTE options, we conducted extensive data collection for 30 calendar days, between the end of July and August 2024. The study focused on SPX 5-wide vertical spreads, a common choice among retail traders due to their manageability and risk-to-reward profile. 

For each trading day, spreads were sampled from approximately 15 points In-the-Money (ITM) to 15 points Out-The-Money (OTM) in 5-point increments. Quotes for each spread were captured every market minute, providing a detailed timeline of premium decay throughout the trading day.

We then plotted spreads at a particular distance from the money, +/- 1 point. A 10-point OTM quote was only considered relevant if the nearest short strike was between 9 and 11 points OTM. If the distance was between 7.5 and 9 points or 11 and 12.5 points, the quotes were omitted even though the OTM amount would have rounded to select the same short strike as the previous minute.

At-the-money (ATM) quotes were considered when the short strike was within +/- 1 point of the underlying price.

The decision to use spreads rather than single contracts was intentional. SPX contracts are typically expensive, and retail traders often opt for spreads to mitigate costs while still benefiting from directional moves or time decay. By analyzing spreads, we provide insights that are more relevant and practical for the average trader.

Analysis

Let’s start by reviewing the generalized Theta Decay curve. It’s an abstract representation of the typical decay curve for options contracts, one most traders are familiar with conceptually. Theta decay accelerates at an exponential rate, with option premiums 30 days from expiration witnessing faster decay with each passing day. Most option sellers will build strategies to take advantage of this rather consistent decay, with all other factors being equal.

Visualizing Decay: SPX 0DTE 10 Points OTM Decay Curve

Now that we have a baseline for what “typical” decay looks like for standard option contracts, let’s look at the decay of 0DTE option contracts with a lifespan of a single trading session. One of the most telling charts is the decay of the 5-wide SPX short put spread at 10 points OTM. This chart captures the essence of time decay as it unfolds within a 0DTE position. 

Figure 2 demonstrates the price decay of a 10-point OTM 5-wide short put spread over a single trading day.

As expected, the spread's value deteriorates as the trading day progresses which seems logical and rational. What’s surprising is the non-linear rate of decay has a noticeable acceleration in the afternoon, particularly after 15:30 (3:30 PM ET). This looks eerily similar to a 90+ days to expiration theta decay curve.

For many traders discussing 0DTE strategies and time decay, the overwhelming assumption has been that time decay for 0DTE options is linear throughout the entire trading session—but that’s not the reality. Traders who enter the market shortly after the opening bell may not see the significant decay they are expecting or banking on for their strategy. Instead, the rapid decay occurs much later in the day, emphasizing the need for patience or careful timing in entering trades.

Exponential Decay and Drop-off at 3:30 PM

The decay curve for 0DTE options often resembles an inverse sigmoid function, where the decay is gradual in the morning, accelerates in the afternoon, and then sharply drops off towards the end of the day, tending toward zero.

We observed the most significant price drop typically occurs around 15:30 (3:30 ET), where the spread's value collapses as expiration approaches. This drop-off is crucial for traders looking to capitalize on theta decay because it means that entering positions too early in the day may result in lower returns, while waiting until the afternoon could maximize the impact of time decay.

OTM vs. ATM vs. ITM Decay

Comparing ATM and OTM spreads reveals distinct decay behaviors.

In Figure 3, we can see ATM spreads retain their value much longer than OTM spreads, even as expiration approaches. However, the reward-to-risk ratio for ATM spreads, on average, is less than 1:1, even though they are closer to the underlying price.

Traders seeking to balance risk and reward may need to consider the diminishing returns of ATM spreads as expiration nears, especially when compared to the rapid decay of OTM spreads.

In Figure 4 we see a prototypical graph of exponential increase trading the 5-wide 0DTE SPX short put spread at 10 points ITM. Keep in mind that this particular position is always in-the-money and will tend toward its maximum value, 5.00, rather than zero.

Although the y-scale is slightly different between Figures 2 and 4, representing the 5-wide short put spreads at 10 points OTM and ITM, respectively, they are very nearly inverses of each other.

Black Monday 2024: A Case Study

On August 5, 2024, Black Monday, the market experienced extreme volatility, and the behavior of 0DTE spreads was particularly interesting. As might be expected during large volatility events, the bid-ask spreads widened significantly, and the mid-price exhibited extreme volatility. This behavior was indicative of market participants' uncertainty and the rapid adjustment of option prices in response to the underlying SPX's sharp movements.

On such volatile days, what might be assumed as the “typical” decay curve can be distorted, and traders should exercise caution. The potential for large, rapid price movements can lead to unexpected outcomes, even in strategies typically reliant on predictable decay.

For example, this 5-wide SPX 0DTE spread held its value a lot longer than we’d expected. Therefore, it’s reasonable to assume when the markets are experiencing higher-than-normal volatility, premiums will stay elevated to account for the additional volatility risk until the final moments of the trading session.

Final Thoughts

The time decay curve of 0DTE options can be thought of as a compressed view of the long-term theta decay seen in options with longer expirations. Understanding the timing and magnitude of this decay is critical for traders who seek to optimize their strategies around 0DTE opportunities. The empirical data suggests that the most significant decay occurs later in the day, contradicting the common belief about 0DTE traders that early entries during the trading session capture the most premium. Our data suggests that early entries don’t capture significantly more premium than entries in the later afternoon, and carry additional directional exposure that could be thought of as uncompensated and unnecessary risk if your goal is to profit from 0DTE time decay.

This study opens the door to several avenues for future research:

Call Side Decay

A similar analysis on the call side could provide insights into whether the decay characteristics mirror those observed on the put side.

Far OTM Analysis

Examining decay behavior for spreads much further OTM, such as 25 or 50 points, could reveal how far out traders can push the boundaries while still capturing meaningful decay.

Spread Width Comparison

Analyzing the decay of 25-wide versus 5-wide spreads, especially when positioned 25 points out, may offer insights into the risk and reward trade-offs of different spread constructions.

Understanding these decay dynamics is essential for refining trading strategies and maximizing the efficiency of 0DTE trades in a highly volatile and time-sensitive market.