0DTE options trading: High risk or hype?

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If you’re a regular follower of financial news, you’ve probably seen media reports about a relatively new phenomenon called zero-days-to-expiration (0DTE) options trading. As the name implies, this refers to options traders getting in and out of options positions on the day they expire.

At first blush, you may be wondering why 0DTE options are suddenly popular—both as a percentage of exchange volume as well as the subject of concern among policymakers. After all, for as long as there have been listed options, there has been option expiration. Option contracts aren’t in force forever. Expiration is when an option is either in the money and exercised, or out of the money and expires worthless.

Every listed option series has—by definition—an expiration day. But with the advent of electronic options trading, along with greatly reduced commissions and tighter bid-ask spreads, traders and investors have gravitated toward certain shorter-term option strategies that can help them reduce risk through hedging or speculate in underlying indexes or stocks.

Over time, Cboe Global Markets (CBOE) and other options exchanges rose to meet the demand for short-term options with more frequent expiration dates. Before 2005, most listed options had one expiration date per month (on the third Friday). Then Cboe introduced SPX weekly options (expiring every Friday). Over the next several years, Cboe would add weekly options to other indexes, as well as exchange-traded funds (ETFs) and individual stocks.

Demand kept rising, particularly for options on indexes and index ETFs. Monday and Wednesday expirations were introduced in 2016, and in 2022, the rest of the trading week was filled in with Tuesday and Thursday expirations. And that’s when (and arguably why) 0DTE options trading really took off.

There are now weekly and daily option expiration dates on top index options, including:

Traders have sought to take advantage of the unique characteristics of ultra-short term trading strategies (e.g., specifically targeting events such as an economic data release or big earnings report). So much so that volume in 0DTE options trading has grown, on average, 58% between 2016 and 2023.

By far the largest volume in 0DTE trading takes place in the cash-settled, European-style (no early exercise) SPX options, which are listed on the Cboe. According to data collected by Cboe:

When you combine those two data points, it’s easy to see just how meteoric the rise in 0DTE options has been. And remember: This is just SPX data.

Contrary to what you may see in the media, trading in 0DTE SPX options isn’t solely the playground of high-risk gamblers looking for a quick lottery ticket win. Some of it might be, but the overwhelming majority of SPX 0DTE traders are vastly different from the meme-stock bubble traders of 2021 who were looking to squeeze stocks higher with leveraged bets in one direction. For one thing, the typical 0DTE trader is using complex option strategies with a sophisticated understanding of “greeks” (metrics for measuring risk).

A majority of these traders are taking a systematic approach to their 0DTE engagement. Cboe data shows that 95% of 0DTE volume is done with defined-risk strategies. One of the most popular approaches among 0DTE traders is selling call vertical and/or put vertical spreads to capture time premium (“theta”).

Many traders take a balanced approach and sell vertical spreads on both sides of the market. In other words, they might sell an out-of-the-money put spread and an out-of-the-money call spread to form what’s called an iron condor trade. Trading in single-leg put or call options is fairly balanced as well; many of these single-leg trades are adjustments to existing 0DTE vertical spreads.

That’s not to say there isn’t a speculative motivation behind 0DTE. Many participants are trading their directional views. But does 0DTE trading pose inherent risks?

Uncertainty. The biggest risk in trading short-term options is the uncertainty. As the market moves around intraday, option contracts can go in the money and out of the money several times. Why does this matter? Two words: delta and gamma.

At expiration, an option is either in the money or out of the money—with absolute certainty. (In option terms, its delta is either 0 or 1.00.)

If the market vacillates above and below a strike on expiration day, so does its delta. That change in delta is called gamma, and it represents uncertainty. When you’re dealing with physical settlement—meaning you might end up with a long or short position in a stock or ETF—that gamma can be unnerving. You could even get assigned a position but not find out until after the market has closed.

Assignment. If you’re trading 0DTE options in cash-settled indexes like the SPX or NDX, there’s no need to worry about intraday assignment risk. But with American-style, physically settled options or ETFs, which allow for early exercise, you could get assigned a position in the underlying and not know about it until after the close of the trading day.

For traders of SPY, QQQ, and other physically settled 0DTE options, another risk—particularly for those new to the game—is forgetting to close a position by the end of the day. If it’s in the money, it will be exercised into shares of the underlying stock or ETF—a nasty surprise if you’re not expecting it, particularly if it’s into a short position. Short selling is a business best left to the pros.

Okay, so an individual trader’s risk is on them. But what about at the aggregate level? Even if you’re not a 0DTE participant, are you in danger of getting caught up in runaway volatility caused by 0DTE traders?

Social media, blogs, and media articles have sought to articulate what they perceive to be grave dangers posed by 0DTE options trading. They’ll often quote the high notional value (the total dollar value) of 0DTE trading, and draw conclusions that the concentrated nature of this activity is rigging and driving the daily price action of indexes like the SPX. They suggest it’s the proverbial tail wagging the dog.

In reality, there’s a big difference between volume and risk. High volume doesn’t necessarily mean high risk. What’s more important is the balance of volume between long and short trading exposure.

All SPX options are traded through the Cboe, and 98% of transactions are electronic. So the exchange has complete transparency on every transaction; it can determine if a trade was initiated by an investor or a market maker, and whether an investor was the buyer or seller. This allows the exchange to see market makers’ net directional positioning (long minus short delta) at each expiring strike.

And what does Cboe data show? On average, market maker net directional hedging flows (long or short) for SPX represent a mere 0.04% to 0.17% of daily liquidity in S&P 500 futures markets (where such risk is typically hedged by market makers). That’s a far cry from the directional hysteria put out by some media outlets.

If you’re an options trader, you may be asking yourself if 0DTE options trading is something you should consider as a strategy. The ultra-short-term nature of 0DTE makes engagement almost a binary event—money can be made and lost very quickly depending on the intraday movement of a stock or index.

Unless you have a detailed risk management plan, a clearly defined exit strategy, and a disciplined contingency plan, it’s probably best to observe expiring options from the sidelines. If you trade options, you should probably liquidate or roll your positions before expiration.

Will 0DTE options continue to be a high percentage of overall volume? If history is a guide, an extended period of ultra-high volatility may scare off—and in some cases, wipe out—those who take on big, open-ended risks in hopes of a massive payoff. During the late 1990s dot-com boom and bust, as well as the meme stock craze in 2021, when the party ended, many players exited the market and never came back.

But for disciplined traders and investors who value choice, and who stay within their defined risk parameters, daily option expiration is another arrow in the quiver of opportunity.