Monthly Archives: June 2022
- The Basics of options expiration
- The frequency of options expiration
- Why European style options are best for 0-DTE
- Options assignment risk
In the world of financial markets there are different security types, like stocks and bonds and futures. Many of these securities are contracts, they are created and exist for a period of time, then they expire. An example of this are options contracts.
During the time an options contract is active, it has a time value, that value is called the premium. As the expiration date nears, the value of that premium decreases until it is completely gone. The rate at which it decreases in value, is exponential. In other words, as you get closer and closer to expiration, the premium value decreases faster and faster.
There are two parties involved in every options contract, there is the creator, also called the writer, who is said to be short the contract. And there is the owner or buyer, who is said to be long the contract. At expiration time the writer of the contract has certain obligations, and the buyer has certain rights that they can choose to exercise, which the writer must fulfill due to their obligation.
When the expiration day comes, the buyer, or the person who is long the contract, decides whether to exercise the terms of the contract or let it expire worthless.
Frequency of Expiration Dates
In the United States there are standardized options contracts that expire at different times. There are monthly options, that expire on the Saturday following the 3rd Friday of a month. If Friday falls on a holiday, then the expiration date is moved up one day.
Weekly options are like monthly options in every respect, except they only exist for 8 days. They are introduced each Thursday, and they expire 8 days later on Friday with adjustments for holidays.
S&P futures, along with S&P and VIX Indexes, have options that expire every day of the week. They are like weekly options, in that they are created 8 days prior to expiration. And they expire 8 days later, every day of the week.
These short term options have become so popular, that they make up nearly 50% of all U.S. options trading volume. I know, crazy right?
These are the options that us traders, at 0-DTE.com, are most interested in. They provide us with incredible strategic advantages, specific to the final day of expiration, 5 days a week.
European vs. American Options
American style options can be exercised at any time. This is fine for stocks with monthly or weekly expirations, but the short time frames of daily expirations simply wouldn’t work, so those options contracts use European style expirations, where they can’t be exercised until they expire. This makes holding options right up until the time of expiration, without fear of being exercised a viable strategy, and there’s plenty of premium left, even down to the final minutes in the life of the contract.
The S&P futures have assignment risk after expiration, where options on the S&P index have no such risk, as they are cash settled. This requires the trader to take this into consideration and be prepared to handle the possibility of managing assignment of futures contracts if they trade the S&P E-mini futures into expiration. Either that, or they simply close their trade prior to expiration.
With the S&P Index, there is no such risk, because there is no assignment, because they are cash settled. So, there’s nothing to do if you hold the contract into expiration. Your broker will simply debit or credit your account after the contract has settled.
- The Basic Strategy
- High Risk vs Low Risk
- Best Strategy for 0DTE
A 0DTE strategy makes money by taking advantage of premium decay, which occurs at an exponential rate until it is completely gone by the final second of the options contract life. The type of options strategies used to collect this premium usually include; the Iron Condor, Butterfly, and in some cases a vertical spread.
Generally 0DTE strategies are applied to European style options so that there is no risk of getting assigned early. So this means options on the S&P futures or index are good candidates, but there’s also options of the Nasdaq futures and Index as well, however there are differences that might make one preferable over the other.
The factors or characteristics of the various available contracts should be considered, those include; the size of the contract, the commissions, liquidity and bid-ask spreads. And another very important factor is when it is traded, for instance futures are traded around the clock, while indexes are available only during market hours. Another factor is how often is it traded, is it one a week, 3 times a week, or 5 days a week.
One additional factor is the very nature of the underlying, and the ability to perform technical analysis on it in order to model your options strategy. Indexes are calculated, they are not traded directly, so there is no volume, where futures are traded and have volume. So if volume is important to you, then futures will be important to you.
The Basic Strategy
Analyze the asset to determine the best time and place to position an options strategy to collect the maximum amount of premium.
Risk is a big factor, so you have to determine the best way to manage risk. There are two risk management schemas or spectrums that you can employ.
- Manage Risk: You can do high probability trades, which mean that the risk is very large compared to the potential profit, however there’s a high probability that you will profit. Which basically means that you need to have strong risk management. With high probability trades you will have a lot of small wins, and hopefully you can manage away the risk of large losses.
- Manage Profit: You can do relatively low probability trades, where the risk is very small compared to the potential return. There’s a lower probability of achieving max profit, however there’s a larger spectrum of positive results, meaning you don’t need strong risk management, you need strong profit management. With low probability trades you may have fewer wins, but your losses will be very small, and you have the chance to have very large returns.
High Risk vs Low Risk
There’s conventional wisdom that you have to risk a lot to make a lot. This is simply not true with options trading. It would be more correct to say that high risk options strategies will produce more winners, but those winners will be very small and the risks will be very large. The idea is that you can manage the risk away, and enjoy beautiful consistent income. This is a pipe dream.
The low probability trade, otherwise known as the asymmetric risk to reward trade, says that you take very small risks so that you are never hurt by any one or any number of losses. And in exchange, you have the chance to make very large returns…but one thing that is not often mentioned, is that you also have the opportunity to make a spectrum of returns from small to large as well. You simply don’t have that with high probability trades, there are no big winners unless you oversize you position and bet the farm and risk ruin.
With the low probability trade there is mathematically a positive outcome if all things are equal and probabilities are normally distributed. With high probability trades there is a negative outcome. This says it all, simply put, low probability trades have an edge over high probability trades.
The problem with most people is that they like the idea of winning a lot, rather than losing a lot, regardless of the size of the wins and losses. They don’t worry about the big potential losses until they hit.
The biggest difference is in the level of anxiety between the two strategies. With high probability trades you are almost always put into a losing situation immediately, requiring you to manage risk most of the time. Where the low probability trader is never in any peril, as the losses are small, so there’s no need to manage them, they are more consumed with managing profits and trying to maximize those profits, particularly when there’s a chance at a max profit which can be quite spectacular. It just doesn’t happen often.
The other thing about the low probability trader that is overlooked is that while they don’t win as often, the amount that they win is almost always much larger than the wins made by the high probability systems. So they have fewer and smaller drawdowns and less volatility in their equity curves. And generally their profits rise faster at a more consistent rate over the longer timeframe.
The Best Strategy for 0DTE
After considerable experience with both strategy regimes and using all the available asset types, it is clear that the best strategy is the low probability asymmetric system, using SPX options to trade and a futures serogate to perform the analysis. This way you get the best of all the various characteristics.
0-DTE.com is the only service that trades this way. In additional to that, we do not use traditional technical analysis, instead we use volumetric analysis, which is considered the standard for institutional and other professional traders.
Our results speak for themselves. Our traders have virtually no anxiety, they make more money on far less capital than the other 0DTE strategies. About 5X more money on 10X less capital.