Zero Days to Expiration (0DTE) Options and How do They Work?
What are options?
Options are financial instruments traded in the derivative segment of the financial markets. Option contracts give its buyer the right to buy or sell the underlying asset at a predetermined price for a specified period. The right to buy or sell can be exercised by the buyer at his/her discretion within the specified duration. The buyer has no obligation to exercise the option. However the seller is obligated to hold up his end of the deal should the buyer choose to exercise his/her option. After the duration stipulated in the option contract is over and the option isn't exercised before it, then it becomes null and void as each option contract has an expiration date.
What are 0DTE options?
The acronym 0DTE options stands for Zero days to expiration options. These option contracts will expire on the same day as they are traded as the duration of the contract has come to an end. These are also known as daily(s) as these option contracts expire every day of the week. There is a short window of opportunity for investors to try and generate a gains from the option contract before expiry.
How do 0DTE options work?
- An investor has to identify the underlying asset class that he/she wants to trade on.
- So if one decides to trade on S&P500 index options, the investor has to simply select the index option and take a position in the market.
- All positions will be squared off at expiry.
Note: 0DTE options are available on select stocks and ETFs with high liquidity.
Why have 0DTE options risen to popularity?
- It is a lucrative opportunity for investors to make a quick buck.
- It is a hit among investors as a premium collection strategy as the time decay is in the favor of options sellers.
- The capital is deployed in a position for a short period of time.
- Entering and squaring off trades on the same day along with the boon of leverage allows an investor to take multiple positions.
What are the risks associated with it?
- Options are leveraged financial instruments that have the bandwidth to wipe out 100% of the capital deployed.
- Option selling has the potential to be very risky if the underlying rallies in the opposite direction. For example, if a stock is in an uptrend on expiry and an investor has sold the call option of this stock, the position creates a very high risk.
What are the essentials that one must be mindful of when trading in 0DTE options?
- Market factors of demand and supply may not always work in the favor of the investor so it is of utmost importance to have the knowledge of how to execute and hedge these trades.
- 100% capital deployed can be wiped out if a single leg naked option strategy is used. So speculative trades at this stage may prove to be risky.