What is the S&P 0DTE Strategy?

0DTE or Zero Days To Expiration refers to the very last day that an options contract exists. This is a very important time in the life of an options contract for a trader because something very special happens on that day, both for the buyer and seller of that contract. We are most interested as the seller, because as the seller you stand to benefit far more than the buyer.

That benefit on the last day is called premium decay. Premium is the extrinsic value of an option, for an out of the money (OTM) option it represents the entire value of that option. Premium decays at an ever increasing rate from the time the options contract is conceived, right up until the moment the contract expires. And at no time does that premium decay faster than the last day, or Zero day, of expiration. As the seller of the options contract, the premium is what you receive for taking on the obligation of insuring the strike price of that contract.

That’s right, you are an insurance salesman when you sell, or write an options contract! And don’t worry about this sounding like a pejorative, it is not, in fact it is the most important job in trading and potentially the most lucrative. Just like in the real world, insurance companies seem to have all the money. There’s no doubt that insurance is a great business to be in.

Well, this is central point to our 0DTE strategy. We sell insurance in the form of S&P options contracts on the very last day of expiration (0DTE). There are two kinds of S&P assets that have options that we concentrate on, they are options on futures and on the index, also known as E-mini S&P futures and the SPX index, respectively. They both have similar pricing and both have contracts that expire 3 times every week; Monday, Wednesday and Friday, unless there’s a holiday where the market is closed, then Tuesday if it’s a Monday holiday, and Thursday if it’s a Friday holiday.

The strategy is to sell S&P options on the last day of expiration and collect the fast decaying premium. We do this by placing an options premium collection strategy, such as a Butterfly spread, with a spread width that is likely going to overlap that day’s range of price movement in the S&P. We optimize the timing and placement of the strategy so that we are presented with an asymmetric risk to reward situation. The better our timing and placement optimization, the greater the ratio between risk and reward. The range can go from 1 to 4 and as high as 1 to 20, risk to reward. Much of this is dependent on the volatility present for that expiration day.

In order to optimize timing and placement of the options strategy, we do a thorough analysis of any potential market catalysts that are likely to set the price in motion. We develop a directional bias and try to determine both the direction and magnitude of that move. We also do a volumetric analysis to generate a market structure, which we use in conjunction with the directional bias to develop price path scenarios. Then we create options strategies that model these scenarios to create profit collection opportunities. After entering a trade, if the price movement is favorable, we employ profit collection strategies to maximize our realization of profit.

So, the strategy is actually comprised of 4 steps, within each step are one or more disciplines, or skill sets. The overall strategy is definitely discretionary. We operate it with some rules, but mostly guidelines that help the trader adopt the strategy to their personal capacity and tolerance for risk. Here are the 4 steps of the strategy:

1. Global macro analysis to determine catalysts for price vector (direction and magnitude).
2. Volumetric analysis using Volume Profile to determine market structure (support, resistance, value areas)
3. Options modeling, bringing together steps 1&2 and optimizing for risk to reward.
4. Profit management strategy

These 4 steps are what comprise our primary directive, the trade. However we put on a trade several times a week, under many different conditions, and so there is a larger process that governs these individual discrete opportunities. We might even refer to each trade as a mini project. Our main goal is to maximize our return on capital used with the least amount of drawdown possible. We also want to learn from each trading instance, so we envelop all trades with a continuous improvement process that borrows from agile processes in the areas of manufacturing and production, software development and management processes.

We take from well established processes and philosophies like Kaizen, Kanban IkiGai, and Scrum to create our own continuous improvement process. We have no name for it currently, so we’ll just call it C0DTE, which stands for Continuous improvement of the Zero DTE strategy. I will post more about this in the future.