Just as people don't like growing old and watching their bodies fall apart, neither do they like watching their options trades grow old and "decay."
That's one reason why you've been hearing so much about "0DTE," or zero-days-to-expiration options. They essentially take the growing old part out of the trades.
Many options trades suffer from what's called "time decay." This is especially true for those options trades whose "strike" price equals the stock's going market price, say $10 vs. $10. Essentially, the value of the contract erodes over time with the pace of this decay speeding up as the option gets closer to expiring. (Think how our hair goes white, falls out and bones get brittle the older we get.) As time goes on, the trader has less and less time to see a profit from the trade.
To skip the getting old part, option traders are opting to live fast and die young, or, at least let their trades to that. They simply buy options on the day of expiration, hoping for a big move in the direction they choose. They are in effect minimizing, or eliminating, time decay.
If you think the market will rise during the trading session, you buy calls. If you believe the market will fall sharply (as it did on Tuesday), then you would buy puts -- which increase in value as the price of the stock falls. These instruments -- options -- can pay off with some very heavy returns if you catch the right direction. But there is inherent risk too, as you need to be right for the duration of the trade -- minutes or hours.
Yes, buyers of 0DTE need price action in a very small time window. The S&P 500 fund ( SPY
) and the Invesco fund ( QQQ
) are now popular for 0DTE trades -- have options expiring every day. How convenient and generous that CBOE ( CBOE
) would offer more expirations to choose from! Your 0DTE doesn't work on Wednesday? Fine, we'll try for Thursday. No good? There is always Friday.
This is the same mentality as futures traders: The best traders are disciplined to go flat (not holding a position) by the end of the day. These 0DTE option traders will go flat by the end of the day, either booking a profit or taking losses. This style of trading of course is not new, but it is becoming popular. If you remove the decay factor from the option, or most of it, you're only fighting the momentum of the market, or going with the flow. An index option such as the SPY or QQQ does not have to move enough to overcome the decay and become profitable. Further, since options are a cash-only instrument, you can only lose what you put into the play. Remember, an option is made up of time decay and perhaps some intrinsic value if the option is in the money.
Now, option prices are not just set randomly. There is a formula based on expected move, which is derived from open interest, demand and historical movement. Option prices are dynamic, market makers are between buyer and seller to provide liquidity and balance to create a fair market. SPY options often have very large open interest. The recent rise of these 0DTE option traders along with the daily expirations has increased the demand and open interest exponentially.
A Closer View of 0DTE
Let's take a look at the montage for options expiring on Wednesday. Volume shows N/A, as this was taken before the markets were open.
But look at the open interest column for calls and puts. There is enormous interest in call and put strikes from $392 up toward $405. On Tuesday, the SPY closed at $398.27, right in the middle of that range. What does this mean in plain English? There are already some heavy bets made on a big move happening on this day. And we expect to see even more buying of calls and puts when the market opens. As a reminder, at expiration if an option is at or in the money, it will be exercised. An option out of the money will expire worthless.
Looking to the montage again, we see the biggest open interest in calls is at the $400 strike and higher, while put interest is high at $400 or lower. I guess we could say the biggest pain point for 0DTE players would be if the SPY finishes the day right at $400. At this level, most options will become worthless and the ones who sold options to these buyers would be huge winners (remember, options are a zero sum game -- a winner and a loser). The premium paid that $400 strike for calls and puts, or the straddle is roughly 3.28. We get that by adding the call and put together, that is the expected move today, which is just under 1% the price of the underlying SPY ($3.28/$398). With market volatility low, it seems a stretch to get to a 1% move, but any news can trigger a slew of buying or selling.
Remember now, this is before the market is open. So, those 0DTE traders are looking at this before the open to decide, which option is the right one add.
Options trading is unique in that you have defined risk. If a trade doesn't work out today and you can walk away from a loser, you can always try it tomorrow, if you still have the money to do so. I would not suggest playing 0DTE on a regular basis nor substitute for your long-term investment strategy. But if you get on the right side of a move, the payoff can be substantial. A good exercise would be track your wins and losses and see how they stack up. Can you win at 0DTE more than 50% of the time?
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