Zero-day options: What to know about this risky short-term trading strategy
Zero-day options have increasingly become a trading tool for “go-for-broke” retail investors. But despite that fancy name, zero-day options are regular options with just one day until expiration.
Because of this, zero-day options can act like options on steroids. The right options could soar thousands of percent on their last day of existence. However, most finish the day worth basically their trading price of the day before — either some amount of money or almost nothing at all.
Here are the key things to know about zero-day options and how they do help you go for broke.
What are zero-day options and how do they work?
Zero-day options are options contracts that are set to expire before the end of the day. They are not special options contracts but rather regular options with just one day of existence. That day of existence may be because an option that has existed for weeks or months is set to expire that day or because a zero-day option was created from the start to exist for just that one day.
Zero-day options are sometimes abbreviated 0DTE, representing zero days to expiration.
Zero-day options have gained in popularity in recent years, as traders shoot for the moon. The number of contracts that traders opened on the option’s last day soared 60 percent between January 2022 and January 2023, according to the Financial Industry Regulatory Authority (FINRA). And individual traders are helping lead the charge, increasing their zero-day wagers by 75 percent over the same period.
So what makes a zero-day contract so interesting to traders? Here’s the background you need to know.
The price, or premium, of an option is composed of two elements:
- Intrinsic value
- An option’s intrinsic value is the difference between the strike price of an option and the price of the underlying security.
- Time value
- An option’s time value is any additional value beyond the intrinsic value. This extra value accounts for a variety of factors such as the security’s volatility, the time until the option’s expiration and the cost of money (interest rates), among others. All else equal, the longer until the option’s expiration, the higher the option’s time value.
For example, imagine buying a $40 call option for a stock that’s trading at $42 for $3. The option’s intrinsic value is $2, or $42 – $40. Meanwhile, its time value is $1, or $3 – $2.
Here’s what’s interesting to traders: With zero-day options, the time value of a given option is low, almost non-existent, since it has just one final day of existence remaining. So, traders may be able to buy a zero-day option and pay very little for the time value, while enjoying huge upside if the security moves significantly.
While zero-day options may be particularly risky, other options strategies have limited risks.
Why zero-day options have become so popular
Zero-day options have gained in popularity for one main reason — their exaggerated profit potential — but also for the reasons that make options as a whole seem attractive.
- Options already provide the opportunity for generating high returns, and zero-day options magnify this potential even more through the power of leverage and the low cost of time value.
- Options prices can be volatile, giving traders a chance to profit even from a small change in the price of the underlying stock.
- With zero-day options, it can cost less to get the same exposure to a stock’s price movement than it does to buy the stock directly or a longer-lived option.
- Even a stock’s normal daily volatility might swing the price enough to make an option profitable, but other positive news such as an earnings report or buyout could send options skyrocketing hundreds or even thousands of percent.
- It’s cheaper than ever to trade options, with commissions at ultra-low levels at several of the best brokers for options traders. Some brokers even offer free options trading.
- The potential to buy low-priced zero-day options means you can take a lot of different bets on various options contracts, hoping for one to soar.
In short, zero-day options provide those traders with a gambling streak to make many times their money in just hours, if the security price moves their way.
Trading zero-day options: How much money can be made?
Let’s run through an example to show you how zero-day options can return so much money.
Imagine you can purchase a $20 call option on a $20 stock for $0.10, with the option expiring at the end of the day. The total cost of a single contract is $10, or 100 shares * 1 contract * $0.10.
Then, let’s imagine you buy 10 of these contracts for a total of $100.
Below is a table showing the profit and loss at the end of the day for a variety of stock prices.
| Stock price | Option value | Total profit | Stock gain/loss | Option gain/loss |
|---|---|---|---|---|
| $19 | $0 | -$100 | -5% | -100% |
| $19.90 | $0 | -$100 | -0.5% | -100% |
| $20 | $0 | -$100 | 0% | -100% |
| $20.10 | $100 | $0 | 0.5% | 0% |
| $20.50 | $500 | $400 | 2.5% | 400% |
| $21 | $1,000 | $900 | 5% | 900% |
| $22 | $2,000 | $1,900 | 10% | 1,900% |
At every stock price below $20, the option holder would lose the entire amount staked. At stock prices between $20 and $20.10, the option would have some value, but the option holder would still have a net loss. At stock prices above $20.10 — the strike price plus the cost of the option — the option holder would begin to make money on the bet, with significant leverage to the stock.
For example, if the stock moves just 2.5 percent, then the option goes up 400 percent in value. A 5 percent move would lead to a 900 percent gain in the option.
These massive gains in a short time frame are what traders of zero-day options are hoping for. A stock’s normal daily swings may push the option into being valuable, though it’s just as likely that the stock will remain flat or even fall, wiping out the total wager.
It’s especially in these situations that options trading begins to look only like gambling.
What are the biggest risks with zero-day options?
Zero-day options have the same risk profile as regular options, but their abbreviated lifetime before expiration means that risk is heightened still further.
- Options have a fixed life and then expire. At expiration, the opportunity to trade them is over, and these “side bets” on the stock market are settled up.
- With options, you have to pick which stock is going to move — and you also have to time it correctly, two of the biggest risks with options trading. A stock that moves after expiration is meaningless to the option holder.
- Options prices are volatile, and with just hours until expiration, your option can move markedly if the underlying stock moves.
- If the price of the underlying stock moves unfavorably, the price of the option likely won’t recover before the end of the day, potentially leaving the option with a loss or worthless.
- Because options are not guaranteed, you can lose (a lot of) money on them.
- For some options strategies such as short puts, traders can lose more than they receive.
- Options cost more to trade than stocks, where the commission at most major online brokers is zero. Commissions on low-priced zero-day options can eat up a substantial portion of your total bankroll, given their cost relative to the option value.
Those are some of the top risks of zero-day options to watch out for if you’re thinking of trading them.
The bottom line
Because they’re right at the end of their finite life, zero-day options offer the potential for a big score at the cost of a total loss of your money. While longer-lived options may give you time for your bet to be proved right, with zero-day options you have just hours to be right and win.
