Zero-day options have become increasingly popular among retail investors looking to take high-risk trading positions. Despite their fancy name, zero-day options are simply regular options with only one day until expiration.
Zero-day options can be seen as options on steroids, as they have the potential to experience significant price movements on their final day of existence. However, the majority of zero-day options end up being worth either a small amount or nothing at all by the end of the trading day.
Here’s what you need to know about zero-day options and how they can help you take high-risk positions.
Understanding Zero-Day Options and How They Operate
Zero-day options are essentially options contracts that are set to expire within the same trading day. They are not unique types of contracts but rather regular options with a lifespan of just one day. These options may exist either because a longer-term option is expiring on that day or because a zero-day option was specifically created to exist for only one day.
Zero-day options are sometimes referred to as 0DTE, which stands for zero days to expiration.
The popularity of zero-day options has been on the rise in recent years as traders seek high-risk, high-reward opportunities. According to the Financial Industry Regulatory Authority (FINRA), the number of zero-day option contracts opened on the final day increased by 60% between January 2023 and January 2023. Individual traders have also been actively participating in zero-day trading, increasing their wagers by 75% over the same period.
So, what makes zero-day contracts attractive to traders? Let’s delve into the details.
The price, or premium, of an option consists of two main components:
- Intrinsic value
- The intrinsic value of an option is the difference between the option’s strike price and the price of the underlying security.
- Time value
- The time value of an option represents any additional value beyond the intrinsic value. This extra value takes into account factors such as the security’s volatility, the time remaining until the option’s expiration, and the cost of money (interest rates), among others. Generally, the longer the time until expiration, the higher the option’s time value.
For example, if you purchase a $40 call option for a stock trading at $42 for $3, the option’s intrinsic value would be $2 ($42 – $40), while its time value would be $1 ($3 – $2).
Here’s the intriguing aspect for traders: Zero-day options have very low time value, almost negligible, as they have only one day left until expiration. This means traders can acquire zero-day options at a minimal cost for the time value, potentially benefiting from significant upside if the security makes a substantial move.
While zero-day options are considered highly risky, there are other options strategies that come with limited risks.
Why Zero-Day Options Have Gained Popularity
The popularity of zero-day options can be attributed to their potential for outsized profits, as well as the general attractiveness of options trading as a whole.
- Options already offer the opportunity for generating high returns, and zero-day options amplify this potential through leverage and the low cost of time value.
- Options prices tend to be volatile, providing traders with the opportunity to profit from even small movements in the underlying stock price.
- Zero-day options can provide exposure to a stock’s price movement at a lower cost compared to purchasing the stock directly or a longer-term option.
- Positive news such as an earnings report or a buyout can cause options prices to surge significantly, potentially resulting in substantial gains for traders.
- Commission fees for trading options have decreased significantly, making it more cost-effective to trade options. Some brokers even offer commission-free options trading.
- The ability to acquire low-priced zero-day options allows traders to take multiple positions on various options contracts, increasing the chances of a profitable outcome.
In essence, zero-day options enable traders with a risk appetite to potentially multiply their investments within a short timeframe if the security price moves in their favor.
Trading Zero-Day Options: Profit Potential
Let’s consider an example to illustrate how zero-day options can yield substantial returns.
Suppose you can purchase a $20 call option for a $20 stock priced at $0.10, with the option expiring at the end of the trading day. The total cost of a single contract would amount to $10 (100 shares * 1 contract * $0.10).
Now, imagine you decide to acquire 10 of these contracts for a total of $100.
Below is a table demonstrating the profit and loss at the end of the trading day for different 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 stock prices below $20, the option holder would incur a complete loss. For stock prices between $20 and $20.10, the option would retain some value, but the holder would still experience a net loss. However, for stock prices above $20.10 (the strike price plus the option cost), the option holder would start to profit from the trade with significant leverage to the stock.
For instance, a 2.5% stock price movement could result in a 400% increase in the option’s value. A 5% stock price movement would translate into a 900% gain from the option.
These substantial gains within a short timeframe are the allure of zero-day options trading. While a stock’s normal daily fluctuations could render the option valuable, there’s an equal likelihood of the stock remaining flat or declining, leading to a total loss of the investment.
In such scenarios, options trading may begin to resemble pure gambling.
Key Risks Associated with Zero-Day Options
Zero-day options share similar risk characteristics with regular options, but their short lifespan before expiration heightens the level of risk.
- Options have a fixed lifespan and expire at a certain point, after which trading ceases, and the outcomes are settled.
- With options, you need to accurately predict both the stock that will move and the timing of that movement, which are among the primary risks of options trading. Any stock movement after expiration does not impact the option holder.
- Options prices are highly volatile, and with only a few hours until expiration, the option’s value can fluctuate significantly if the underlying stock price changes.
- If the underlying stock price moves unfavorably, the option price may not recover before the end of the trading day, resulting in a loss or rendering the option worthless.
- Due to the non-guaranteed nature of options, there is a potential to incur significant losses.
- Certain options strategies, like short puts, can lead to losses exceeding the initial investment.
- Compared to stock trading with zero commission fees at many online brokers, options trading typically involves higher costs. The commissions on low-priced zero-day options can consume a substantial portion of the investment, considering their cost relative to the option’s value.
These are some of the primary risks associated with zero-day options that traders should be mindful of before engaging in this type of trading.
Final Thoughts
Zero-day options present an opportunity for significant gains at the expense of total loss. While longer-term options allow time for your investment thesis to play out, zero-day options require swift and accurate decision-making within a limited timeframe to achieve success.