What is 0-DTE

0DTE is an acronym that stands for Zero Days To Expiration. In the context of options, it is the very last day of an options’ contract life, the day prior to it expiring, no longer existing. And that day has very special meaning to traders, because on that day two important things happen.

The first is that the premium in the option is decaying at an exponential rate, right up to the last second of the day, when it finally ceases to exist, and all premium is exhausted. It is an incredible thing to witness, especially if you are on the receiving end of that decay, and the money that is representative of the premium gets deposited into your account.

The second thing that happens is that the terms of the contract get fulfilled. In our case with 0-DTE there are often multiple contracts involved in any single position, like a Butterfly, where there are 4 options contracts. Each of them when expired trigger their terms of those contracts. The only thing we are concerned with is assignment or settlement.

We trade two different contracts, the options on the E-mini S&P futures, and options on the SPX index. The futures option handles assignment with a futures contract, and the SPX option settles assignment with cash.

Getting assigned a futures contract is risky, so when we trade options on futures we rarely, if ever, allow the contract to expire…we exit before expiration to remove the risk of holding a potentially volatile instrument.

The SPX option is much less troublesome, because the settlement is in cash, no risk of holding a volatile instrument. However, those very last seconds of the market prior to the close can get quite volatile, and so even with the SPX we might want to exit prior to expiration to ensure we realize the maximum gains from our position. On some occasions, this is not an issue, so we allow it to expire, to collect the maximum premium decay.

Why We Love Trading 0-DTE

The exponential decay is a huge advantage for traders, because it provides a couple of glaring edges. And as traders we are always seeking the elusive edge, however the edge here is not elusive, in fact it is very easy to see, to quantify and to take advantage. The real mystery is why more traders do not use these edges.

The first is the overstatement of implied volatility (future volatility). This is the principle ingredient for determining the amount of premium or extrinsic value in an options contract. The more IV the more valuable the premium. Humans have the unwitting ability to overstate how bad things will be in the future, and so they think prices could be higher or more volatile, they think situations could be worse, than they often end up being…it’s human nature.

The future is the unknown, and the unknown deserves additional premium due to the risk of the unknown. And so, premium, or the value of future options contracts are essentially overpriced. So, we are in essence as sellers of options premium, selling over priced assets that the market is more than willing to purchase from us. Wouldn’t everyone like to own a business where you could mark up your products and the demand did not go away?

The second edge is asymmetry, and a concept known as optionality of convexity, which I will describe in another lesson. But this is what happens, we follow the principles of Black Swan theory, that we cannot predict when unusual events will happen, yet we can prepare for them and take advantage of them by placing very small bets with the potential for very large rewards. If we encounter a black swan, we get paid very handsomely, if we don’t we lose a very tiny amount. Asymmetry is a winning strategy. And fortunately the size of the wins completely overshadows the small losses between the big wins.

The other edge that is related to asymmetry is optionality and convexity. Optionality simply means that our positions have the ability to produce positive results no matter which way the market moves or doesn’t move. We place trades that produce positive results whether the market moves slightly against us, or if it doesn’t move at all, and of course if it goes in our desired direction. Most traders only win in one direction, they have no optionality.

The reason why we have optionality is because of convexity. We set up trades in such a way that our wins versus losses is not a linear relationship. It lies on a convex curve. Like the convex shape of a telescope mirror that catches all the available light and focuses it to a point. Below is a graph that illustrates this convex relationship.

When we place an asymmetric trade, with overpriced premium and market movements that favor us in most directions, we get an unusual profit curve, where our pain is limited and our gains become amplified in a non-linear convex manner.

This is the essence of our strategy and methods and processes. This is in the words of Nassim Taleb, Antifragile; a system that gains from disorder.  We profit more from disorderly markets. Of course this disorder has its limits and we know what they are, and this is another understated edge that we have.