What is Zero Days to Expiration (0DTE) Options and How Do They Work?

Do you also want to add some excitement to your investing journey? Then, 0DTE trading might be a perfect fit for you. But we need to be cautious as it is similar to a double-edged sword since it can be thrilling and profitable but involves considerable risks.

Today’s blog will help you understand the core concept of 0DTE trading. We will also learn about some common strategies used and the risks involved.

What is 0DTE Trading?

0DTE stands for zero days to expiration. It focuses on buying or selling options contracts that expire on the same day they’re traded.

These options are generally cheaper than options with longer expiration dates because less time is left for the asset to give the expected move. This strategy is popular among option sellers for collecting premiums and option buyers for making huge returns. 

How Do 0DTE Trades Work?

Like any other options trade, a trader will buy or sell option contracts. Buying a call option gives the buyer the right, but not an obligation, to buy the underlying asset at a given price by expiry. On the other hand, buying a put option gives the buyer the right to sell the underlying asset at a given strike price by the expiry date. Sellers of an option contract receive a premium from buyers.

Since the options expire the same day, the main focus is on whether the price of the underlying asset will go up or down within that short time. If the prediction is correct and the price moves in the trader’s direction by expiry, the option contract will increase in value. 

In the case of an option buyer, time is not the trader’s friend. With 0DTE trade, the time decay speeds up. Therefore, to make a profit, the prediction must be correct, and the price movement should happen quickly. However, the loss is fixed, and the potential profit is unlimited.

In the case of an option seller, time is a trader’s friend because as time passes, time decay reduces the option premiums, and the option seller makes a profit. However, in this case, the profit is fixed, and the potential loss is unlimited.

Example of a 0DTE Trade 

Let the current price of Reliance be INR 1950 and the trader bought a call option with a strike price of INR 2,000, expiring later on the same day. The trader has a view that Reliance’s stock price will increase to 2050 by the end of the day.

This option gives you a right but not an obligation to buy 100 shares of Reliance at INR 2,000 per share. There can be two scenarios at the end of the expiry day:

Case 1: If the prediction is correct and by the end of the day, the price of Reliance goes up to INR 2,050, you will make a profit because you have the right to exercise your option and buy 100 shares of Reliance at INR 2,000. Since the market price is now INR 2,050, you can immediately sell those 100 shares at a higher price of INR 2,050.

Case 2: If your prediction goes wrong and the stock price goes down to 1,900. In this scenario, exercising the option to buy Reliance at INR 2000 would not make sense, and since this is a 0DTE option, it will expire worthless at the end of the day, and you will lose the entire premium paid for the contract.

Importance of Theta

Theta is the most important factor that affects the price of the option contract on the expiry day due to the following reasons:

• In 0DTE trading, theta is important because an option contract loses its value as time passes.
• Theta decay in 0DTE options is faster as compared to the options with longer-expirations date. For options expiring soon, theta is very high and causes the option’s price to drop quickly.
• Understanding theta can help a trader choose the right options for trades in 0DTE trading. ITM options have generally lower theta than OTM options which means that ITM options have a slightly higher chance of countering decay if the price moves in the trader’s favor.
• To make 0DTE trade profitable, the price of the underlying asset must increase enough to compensate for the loss caused by the theta decay. The price movement needs to be big and quick within a limited timeframe.

0DTE Options Trading Strategies

In 0DTE trading, multiple strategies can be employed. Some of them are mentioned below.

Credit Spreads

This strategy involves selling a combination of option contracts to collect premiums upfront. To maximize the profit, structure the spread so that you receive the premium as your maximum profit. The maximum loss will be restricted to the difference between the strike price minus the premium collected.

Examples of credit spreads include Bull Put spread, Bear Call spread, etc.

Delta Neutral Strategies

These strategies aim to be neutral by combining options with different deltas. The goal is to profit from the theta decay and the decline in volatility, irrespective of whether the stock price goes up or down.

Different types of delta-neutral strategies include short straddle, short strangle, etc.

Directional Strategies

This strategy involves buying calls or puts depending on the prediction of the movement of the stock price by the expiry time. It provides high returns if the predictions turn out to be accurate, but can be risky as option premium decreases with the passage of time.

Examples of directional strategies involve long straddle, long strangle, etc.

Risks in 0DTE Trading

0DTE trading can be extremely risky due to the factors mentioned below:

Time Decay

When the contract is near its expiry date, the value of options keeps decreasing as time passes. Time decay can reduce the gains, even if the stock that is being traded moves in favor of the trader.

Volatility

Options with a short time left to expiry are greatly affected by changes in volatility. Sudden market changes can cause profitable trades to turn into losing ones.

Psychological Stress

Due to its fast-paced nature, 0DTE trading needs quick decisions and trade execution. The pressure can lead to emotional decision-making and impulsive trades.

Conclusion

To summarize, 0DTE trading can be exciting for option traders, but it is crucial to understand the risks involved. If you are an experienced options trader, you should explore 0DTE trading. The trader should have clearly defined rules of entry and exit along with proper risk management. 

Options trading is complex and requires a solid understanding of the underlying concepts. Hence, one must consult a financial advisor before taking any trades.

Frequently Asked Questions (FAQs)