Zero-day options have become increasingly popular among retail investors looking for high-risk, high-reward opportunities. Despite their fancy name, zero-day options are simply regular options with just one day until expiration.
Zero-day options can be like options on steroids, with the potential for significant gains on their last day of existence. However, most zero-day options end up being worth either their trading price from the day before or close to nothing.
Here are the key things to understand about zero-day options and how they can be used for high-risk trading.
What are zero-day options and how do they work?
Zero-day options are options contracts that are set to expire within the same trading day. They are not unique contracts but rather standard options with only one day until expiration. These options may exist because a longer-term option is expiring that day or because a zero-day option was created specifically for that 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 grown as traders seek out extreme profit opportunities. According to the Financial Industry Regulatory Authority (FINRA), the number of zero-day option contracts traded on the option’s last day increased by 60 percent between January 2023 and January 2023, with individual traders contributing to a 75 percent increase in zero-day wagers over the same period.
So, what makes zero-day options appealing to traders? Here’s the background you need to know.
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 is any value beyond the intrinsic value and accounts for factors like volatility, time until expiration, and interest rates. With zero-day options, the time value is low or almost non-existent due to the option’s imminent expiration.
For instance, if you buy a $40 call option for a stock trading at $42 for $3, the option’s intrinsic value is $2 ($42 – $40), and the time value is $1 ($3 – $2).
What attracts traders to zero-day options is the low time value of these options, allowing traders to potentially pay less for time value while having the opportunity for significant gains if the underlying security makes a substantial move.
While zero-day options can be highly risky, there are other options strategies with more limited risks.
Why zero-day options have become so popular
Zero-day options have gained popularity primarily due to their potential for exaggerated profits, along with the inherent appeal of options trading as a whole.
- Options offer the opportunity for high returns, and zero-day options amplify this potential through leverage and minimal time value costs.
- Options prices can be volatile, providing traders with the chance to profit from small changes in the underlying stock price.
- With zero-day options, traders can gain exposure to a stock’s price movement at a lower cost compared to buying the stock directly or a longer-term option.
- Positive news such as earnings reports or buyouts can cause options, including zero-day options, to skyrocket in value.
- The cost of trading options has decreased, with some brokers offering low commissions or even free options trading.
- Investing in low-priced zero-day options allows for multiple bets on various contracts, increasing the chances of a significant return.
In essence, zero-day options enable traders with a risk appetite to potentially multiply their investments in a short period if the security price moves in their favor.
Trading zero-day options: How much money can be made?
Let’s walk through an example to illustrate how zero-day options can generate substantial returns.
Suppose you can buy a $20 call option for a $20 stock at $0.10, with the option expiring at the end of the day. The total cost of one contract would be $10 (100 shares * 1 contract * $0.10).
If you purchase 10 of these contracts for a total of $100, consider the potential profit and loss at the end of the day for various 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% |
Below $20, the option holder would experience a total loss. Between $20 and $20.10, there may be some value in the option, but the net result would still be a loss. Above $20.10, the option holder would start making a profit, with significant leverage relative to the stock price.
For instance, a 2.5% stock price movement could lead to a 400% increase in the option’s value, while a 5% move could result in a 900% gain in the option.
Traders of zero-day options aim for these significant gains within a short timeframe. While a stock’s daily fluctuations may make the option valuable, there is an equal chance that the stock remains unchanged or falls, resulting in a loss of the entire investment.
In such scenarios, options trading can resemble pure gambling.
What are the biggest risks with zero-day options?
Zero-day options share the same risk characteristics as regular options, but their short lifespan before expiration increases the level of risk.
- Options have a fixed expiration date, after which trading ceases, and any open option positions are settled.
- Traders must correctly predict both the direction and timing of a stock’s movement, which are key risks in options trading. Any stock movement after expiration is irrelevant for the option holder.
- Options prices can be highly volatile, and with just hours until expiration, option values can change significantly with the underlying stock’s movement.
- If the underlying stock price moves unfavorably, the option price is unlikely to recover before expiration, resulting in a loss or worthless option.
- Options are not guaranteed, and traders can incur substantial losses.
- Certain options strategies, like short puts, can lead to losses exceeding the initial investment.
- Compared to stock trading, options trading is more expensive due to commissions, especially with low-priced zero-day options that can consume a significant portion of total funds.
These are the primary risks associated with trading zero-day options that traders should be aware of.
The bottom line
Zero-day options offer the potential for significant gains in a short period but come with the risk of losing the entire investment. Unlike longer-term options that provide time for a bet to play out, zero-day options require swift and accurate predictions to profit.