0DTE options, short for "zero days to expiration," have gained significant attention recently. They offer unique opportunities and challenges for options traders.
In this guide, we'll explore 0DTE options, how they differ from other options, and how you can use them in your trading.
What are 0DTE options?
0DTE options are contracts that expire on the same day they are traded. Unlike traditional options, which might expire weeks, months, or even years in the future, 0DTE options have an very short lifespan. This unique characteristic means traders are dealing with an asset that is essentially a "same-day" bet.
How is 0DTE different from Other Options?
The primary difference between 0DTE options and other options lies in their expiration timeline. Traditional options can be categorized based on their time to expiration: weekly, monthly, quarterly, and long-term options (LEAPS). These options give traders various timeframes to execute their strategies, whether they are for speculation, generating income, or hedging.
0DTE options, however, may require traders to make rapid decisions. The absence of extended time before expiration means that these options are highly sensitive to price movements of the underlying asset and often cannot be adjusted. The trade’s duration is much shorter and the outcome is known within hours, not days or weeks.
The Rise of 0DTE Options
The Cboe introduced weekly contracts for SPX in 2016, and launched daily expiration in 2022. 0DTE SPX options have grown exponentially in the last two years, as traders flock to same-day strategies. More expirations means more opportunities, and daily SPX trading began to boom.
In 2023, 0DTE trading now made up 43% of all SPX volume across all time frames. (0DTE is now 49% of SPX volume).
0DTE key concepts
To understand any options strategy, including 0DTE, it's crucial to have a basic understanding of some fundamental concepts:
Intrinsic value
The intrinsic value of an option is the amount by which it is in-the-money (ITM). For call options, this means the underlying asset's price is above the strike price. For put options, it means the underlying asset's price is below the strike price. On expiration day, an option’s moneyness can determine whether or not it is profitable.
For example, if a call option has a strike price of $10 and the underlying stock is trading at $105, the intrinsic value of the option is $5.
For 0DTE options, the intrinsic value is especially critical as there is no additional time for the price to move further in the trader's favor.
Time decay (Theta)
Time decay, also known as theta, refers to the erosion of an option's value as it approaches its expiration date. All else being equal, an option loses value as time passes.
This concept is magnified in 0DTE options because there is no time left beyond the current trading day, so theta’s impact is significant. Options that are out-of-the-money (OTM) at the start of the day will rapidly lose value if the underlying asset does not move significantly in their favor.
Traders need to be aware of how time decay impacts their positions, as it can quickly turn a profitable trade into a losing one. Long options and debit spreads are negative theta, while short options and credit spreads are positive theta; they benefit as time decays the options’ value.
However, 0DTE time decay tends to increase rapidly near the end of the trading day.
Implied volatility (IV)
Implied volatility (IV) measures the market's expectation of future volatility of the underlying asset. Higher implied volatility indicates a higher expected movement in the asset's price, which can increase the premiums of options. Higher implied volatility typically results in higher option premiums, meaning option contracts are more expensive.
Traders often look at IV to gauge the potential for large price swings and to decide whether an option is over or undervalued. However, since 0DTE options expire the day they’re opened, rising or falling IV may not impact the trade’s outcome as much as longer-dated positions. One exception is singular market events such as earnings, which can benefit from IV crush.
Benefits of 0DTE
0DTE options have garnered popularity among traders for several reasons:
Instant results
The primary allure of 0DTE options is the potential for substantial profits within a single trading day. Because these options are highly sensitive to price movements, even small changes in the underlying asset can lead to significant percentage gains. This potential for quick returns and knowing the outcome quickly is attractive to traders looking to capitalize on intraday volatility.
Increased trading opportunities
Many underlying assets, specifically indexes like SPX and ETFs like SPY and QQQ, offer 0DTE options five days a week, giving traders more frequent opportunities.
No overnight risk
DTE positions expire at the end of each trading day, meaning trades are not held overnight. There is no added risk of major market moves while the market is closed and trades can be exited immediately during market hours.
0DTE risks
While 0DTE options offer enticing opportunities, they are not without risk. The same characteristics that provide the potential for rapid gains include certain considerations. The short time frame means there is little room for error, and traders must be prepared for quick decision-making and disciplined risk management.
Market volatility
Given their sensitivity to price movements and implied volatility, 0DTE options can experience wild price swings. This volatility can lead to large gains or losses in a matter of minutes. Gamma is a measure of an option’s rate of change in relation to the underlying asset’s price.
Gamma risk increases as an option approaches expiration because time decay is greater for near-term options than it is for longer-term options. Therefore, any move in the underlying, especially for in-the-money options, are magnified and can significantly impact the option's price near expiration. Gamma risk is less prevalent in out-of-the-money options and options that are further from expiration.
Time decay
As mentioned earlier, the impact of theta is magnified for 0DTE options. The rapid time decay can erode the value of an option quickly, especially if it remains out-of-the-money. While this is good for options sellers, traders who buy 0DTE options need to be aware of theta’s impace as the market approaches end of the day.
How to trade 0DTE options
0DTE options enable us to express our market bias in multiple ways based on what we think the market is doing. This allows traders to execute quick trades to take advantage of short-term opportunities and get results quickly.
0DTE options strategies
0DTE strategies trade the same as longer-dated options postiions. The key difference is the trade is open for that trading session and expires at the end of the day. Therefore, every 0DTE position is a day trade.
0DTE trades are impacted less by volatility and most of the time decay occurs very late in the day. Gamma can have the most significant impact on 0DTE positions because any price changes are magnified with such a short holding period.
Iron condor
An iron condor is a neutral strategy with limited profit potential and defined risk. Iron condors benefit if the underlying stock price stays within a range.
Iron butterfly
Like iron condors, an iron butterfly is a neutral strategy with limited profit potential and defined risk. It works best if the underlying stock is rangebound. Iron butterflies typically collect more credit than iron condors but may require more management, as one of the short strikes will always be in the money.
Short put spread
A short put spread, or bull credit spread, allows traders to take a bullish position on the ticker symbol. Short put spreads are risk-defined credit spreads that will realize the max profit if the stock stays above the short put strike.
Short call spread
Feeling bearish? A short call spread, aka bear credit spread, capitalizes on falling prices. They will hit max profit if the underlying price is below the short call at expiration.
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