Zeroing In on an Options Trading Strategy: 0DTE

There’s a strategy for trading options that’s generating quite a bit of buzz: trading an option contract with zero days to expiration (0DTE). An online search will generate many results with information about this trading strategy, which has become more common recently as expirations in certain options have expanded to practically every day of the week. Though the topic is hot, selling and buying options with zero days to expiration can be risky.

Options Overview

Before engaging in 0DTE options trading, it’s critical to fully understand the essentials of options. Options are financial instruments that convey to the purchaser (the option holder) the right, but not the obligation, to buy or sell a set quantity or dollar value of a particular asset at a fixed price (known as the strike or exercise price) by a set date (known as the expiration date).

Options generally come with different risks depending on many factors, including, among others, how they’re traded, how they’re settled and the underlying asset. These risks may be amplified if an investor writes uncovered options (meaning the investor sells a call or put option without having a position in the underlying security). For example, uncovered call writers (sellers) face the risk of unlimited potential loss if the market for the underlying security rises sharply.

If you use margin for options trading, you should understand the unique risks of margin accounts as well. You should also be aware of the pattern day trading requirements, as opening and closing a 0DTE option on the same day will be considered a day trade under applicable rules.

What Are 0DTE Option Strategies?

Every option contract expires on a specific date. DTE stands for “days to expiration” and represents the time remaining until an option contract expires. Depending on its underlying asset, an option may expire quarterly, monthly, weekly or even multiple times per week. A 0DTE strategy establishes a position on the option contract’s expiration day, though these option contracts may have been listed days, weeks or months ago. The option contracts could be tied to the price of indexes, exchange-traded funds (ETFs) or single stocks.

Use of 0DTE option strategies is on the rise. The number of opening 0DTE option contracts positions increased approximately 60 percent between January 2022 and January 2023. The increase was even larger—approximately 75 percent—for opening 0DTE option contracts positions by retail customers during the same time frame.

One potential draw of 0DTE options is that they provide an opportunity to capitalize on positions quickly and limit the time that money is tied up. 0DTE options tend to have lower premiums (the price paid by the purchaser of an option contract or the price received by the seller of an option contract), which can make them a less expensive vehicle to use to take a position on short-term volatility in the underlying asset. While these features may seem attractive in some regards, understanding the attendant risks is important.

What Are the Potential Risks?

Remember that any strategy that can quickly earn profits can quickly bring losses as well. That includes 0DTE options, which are very sensitive to changes in the price of the asset underlying the option.

You should also be aware that, before the close of trading, your brokerage firm may evaluate whether an option position has the potential to be in-the-money (when the market price of the underlying security is above the strike price of a call option or below the strike price of a put).

For options that are physically settled (as is the case with most options on equities), your firm may liquidate the position prior to the close of trading if you don’t have the required funds or shares of the underlying security to meet the potential purchase or delivery obligation upon exercise of an in-the-money option. For cash-settled options (such as certain index options), your firm may be less likely to liquidate a position that is at risk of being in-the-money since, unlike physically settled options, you generally wouldn’t need additional funds or shares of the underlying security to exercise cash-settled options.

If your firm opts to liquidate your option position prior to the close of trading, your firm may place an order for you at a price that might limit potential profits or even lead to potential losses. The potential loss or limit on profit might be heightened when an 0DTE opening trade is made closer in time to when the firm is making this liquidation decision.

Below are two examples that illustrate these risks.

Example 1: If a security is trading at $54, you could sell 10 0DTE calls at a $55 strike price for $1. If the security closes on that day at $54, you’d earn the $1,000 premium ($1 option price multiplied by 10 call option contracts multiplied by 100 shares per option contract). As noted above, because the option was close to being in-the-money, your firm may decide to liquidate your option position prior to the close of trading if you don’t have sufficient funds in your account to meet your delivery obligations. This might limit your profit or lead to a loss.

If the security closes that day at $60, you’d have to sell the security at $55 (the strike price). In this example, you’d lose $4,000 (the $5,000 difference between exercise value and the prevailing market value at exercise, less the $1,000 premium received). Similar to the above, the firm may decide to liquidate your option position prior to the end of the trading day, which might impact the total loss.

There are risks on the buy side as well. You might purchase 0DTE options hoping to make a short-term profit on a significant move in the underlying security. This might be tempting because of the lower value of the option, but the option has a lifetime of only one day and you could lose the entire premium paid.

Example 2: If a security is trading at $49, you could purchase 10 0DTE calls at a $55 strike price for $2 (paying a $2,000 premium for the option). If the security closes at $54, you wouldn’t exercise the call option because the strike price is above the closing price of the underlying security, and you’d therefore lose the $2,000 premium. Again, your potential loss might be impacted by a liquidation decision by your firm.

If the market moves above the strike price of the call option and the security is trading at $60 at the end of that day, you could recognize an overall profit of $3,000 by exercising the 0DTE calls at $55 and selling the security at $60, i.e., the prevailing market value at exercise ($60,000) less the exercise value ($55,000), less the $2,000 premium paid. You could also profit by selling the in the money option prior to expiration at a higher price. However, your brokerage firm may make a liquidation decision, limiting potential profits or leading to potential losses.

Additional Investor Considerations

Options can play a number of different roles within an investment portfolio, but they also have risks that investors might not always fully understand. Before you decide to invest in any product, make sure you understand what it is and how it works.

Options trading requires specific approval from your brokerage firm. For information about the inherent risks and characteristics of the options market, refer to the Characteristics and Risks of Standardized Options, also known as the Options Disclosure Document (ODD).