Zeroing In on 0DTE Options? Learn the Basics

January 3, 2024 Advanced
Explore the popularity of 0DTE options trading. With increased volume comes tighter spreads but beware of market volatility. Learn about the potential risks and rewards.

The following, like all our strategy discussions, is strictly for educational purposes only. It is not, and should not be considered, individualized advice or a recommendation. Options trading involves unique risks and is not suitable for all investors.

By midyear 2023, zero-days-to-expiration (0DTE) options strategies had grown to more than 40% of all options trades tied to the S&P 500® index (SPX), according to a midyear report by Bloomberg. That explosive growth came less than a year after daily expiration trading began in the SPX and other major indexes. However, 0DTE trading has drawn scrutiny from some who believe it's making underlying assets and markets in general more volatile.

What is a zero-days-to-expiration (0DTE) option?

0DTE option is an options contract set to expire at the end of the current trading day. Every options contract on an underlying optionable, index, stock, or ETF, whether it was issued a month ago or just last week, becomes a 0DTE on its expiration date. And that's important to know because options can experience significant price swings right before they expire.

Cboe®, the world's largest options exchange, introduced weekly SPX options that expire on Fridays in 2005. In 2016, the exchange listed SPX weeklies that expire on Wednesdays. By 2022, Cboe had introduced weekly options with expirations on every trading day of the week. Now, qualified option traders can trade 0DTE SPX options (and options on a handful of ETFs that track the major indexes) every market day.

What's powered their growth?

According to the Financial Industry Regulatory Authority (FINRA), between January 2022 and 2023, the number of opening 0DTE options positions increased approximately 60%, and for retail customers, the number of opening 0DTE options positions during the same period jumped a bit higher—approximately 75%.

So, why would a trader consider an option with the average lifespan of a mayfly? Here are some possible reasons:

  • 0DTEs expire just after the market close (4:15 p.m. ET), limiting overnight market risk. 
  • 0DTE options are potentially less expensive compared to options with more days to expiration, or DTE (premiums can be in cents for 0DTEs versus dollars for longer-DTE options).
  • The 0DTE market tends to exhibit little difference between the bid and ask price of each option—also known as a tight spread. Tight spreads can help limit trading costs in 0DTE options.

Where the risk comes in

Because 0DTE options have a trading life of only one day, they may lose most of their value within a trading session due to time decay—a concept known as theta. Then there is gamma, which tracks changes in the delta of an option, which makes it highly attuned to the price of the underlying asset. So, in a single trading session, even a minor change in the price of the underlying asset of a 0DTE option can greatly affect the value of the option before it expires.

In some common 0DTE strategies, traders may be speculating on a relatively rangebound-to-lower trading session, for example. If the market moves lower, those who sold can pocket the premium received for selling the call option. However, the market may have some surprises in store for traders if the underlying security's value moves above their strike price. That's why many experienced traders think it's essential to consider stop order protection to potentially avoid assignment, though such a result is not guaranteed. A stop order is intended to limit losses and for options will be a sell order (to close) if the position is long or a buy order (to close) if the position is short. In this example, the trader sold a 0DTE, so the stop order would be to buy back the option, likely at a loss depending where the stop order was placed. 

In such a limited time frame, unexpected volatility can teach serious lessons. The figure below shows an example of what could go wrong. On July 11, 2023, after trading in a range most of the day with the options prices of the various 0DTEs falling, the SPX rallied sharply going into the close. With June's Consumer Price Index (CPI) scheduled for release the next day, part of the surge was attributed to traders positioning themselves for the key announcement, which generally happens with other scheduled data releases or events. However, next came a short squeeze sparked by short covering on positions late in the day that were triggered by the rally. 

In the final 20 minutes of the trading session on July 11, 2023—the day before June CPI was announced—the S&P 500 index (SPX)—suddenly moved higher before the closing bell and triggered an apparent short squeeze.

Data source: Cboe. Chart source: thinkorswim®Past performance is no guarantee of future performance. For illustrative purposes only.

Finally, a word about account management

The pattern day trader (PDT) rule applies to traders who execute four or more "day trades" within five rolling business days. If the number of day trades exceeds the PDT limit, the rule then requires the trader to maintain an account balance above $25,000 going forward. Failure to do so will add restrictions to the account, such as limiting the trader to only close existing positions.

On an administrative trading note, if a trader opens and closes a 0DTE options contract on the same day, it'll be counted as a day trade, which is defined as opening and closing a position on the same trading day. However, if they buy or sell a 0DTE option and it expires worthless, it will not count as a day trade.

Because they are short-lived instruments, ODTE options positions require close monitoring, as they can be subject to significant volatility. Profits can disappear quickly and can even turn into losses with a very small movement of the underlying asset.

Just getting started with options?

Today's Options Market Update

Investors are on edge as volatility spiked this morning as they await Nvidia earnings after the close. Expectations are for a sharp move in either direction depending on the results. Fed minutes are also anticipated later.

Weekly Trader's Outlook

Stocks have remained buoyant this week, despite higher yields and hotter inflation data. Will Nvidia's earnings alter recent bullish sentiment?

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. 

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled "Characteristics and Risks of Standardized Options" before considering any option transaction. Supporting documentation for any claims or statistical information is available upon request.

With long options, investors may lose 100% of funds invested.

Uncovered options strategies are only appropriate for traders with the highest risk tolerance, involve potential for unlimited risk, and are only allowed in margin accounts.

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