0dte Options: A Comprehensive Overview

0dte options, also known as zero-days-to-expiration options, have recently gained significant traction in the world of trading, particularly among retail investors. These options, as the name suggests, expire on the same day they are traded, introducing a unique set of characteristics and challenges. In this comprehensive overview, we’ll delve into the intricacies of 0dte options, examining their advantages, drawbacks, and strategies for effective utilisation and comparison on Indian context.

Advantages of 0dte Options:

1. Low Cost: Due to their lack of time value, 0dte options are generally less expensive than longer-term options, making them an attractive choice for traders seeking quick profits.

2. High Volatility: The limited time frame of 0dte options often leads to heightened volatility, offering traders the potential for substantial gains. However, this volatility also amplifies the risks involved.

3. Limited Risk for Option Buyers: Unlike option sellers, option buyers in 0dte trades face a clearly defined maximum loss, limited to the premium paid for the option. This allows traders to manage their risk by carefully selecting strike prices and expiration dates.

Changing Dynamics of 0dte Options in India:

The advent of 0dte options is very recent in global indices history, from April 2022, SPX started offering option expiries on Monday, Wednesday and Friday. And from Sept 2022, Tuesday and Thursday expires were added.
The introduction of 0dte options in India, following SPX, has brought about a significant shift in market dynamics, particularly with the advent of Banknifty weekly expiries on Wednesdays in September 2023.

The S&P 500 (SPX) is a broad stock market index that tracks the performance of 500 of the largest publicly traded companies in the US. SPX 0dte experies are also happening daily for the same index. As a result, it is less volatile than the NSE/BSE 0dte indexes, which track the performance of a smaller number of companies (12–50) that often overlap between indexes and expiries.

For our context, the correlation between the 0dte expirations, which change from day to day, is even more striking. The Nifty 50 remains our mother index due to its broad components and largest volumes.

This has a significant impact on the dynamics of the option chain, which many traders rely on. While a directional move is typically indicated by OI unwinding in that direction, the move may not be supported and may reverse due to correlation and weightings. This occurs because OI is built up on the mother index while it is unwinding on the expiring index, ultimately causing market reversals.

This, along with the subsequent addition of 6 equity index expiries in 5 days, has led to several notable changes:

1. Increased Success for Option Buyers: Option Buyers have witnessed higher rewards with limited risks from 0dte trades, benefiting from the heightened volatility and shorter time frame.
2. Diminishing Probabilistic Edge for Sellers: The probabilistic edge that option sellers typically enjoyed has become less reliable due to the changing market dynamics and increased correlation among indexes.
3. Irrelevance of Quantitative Backtests: Traditional quantitative backtests, based on historical data, have become less relevant in predicting option behavior due to the dynamic nature of 0dte expiries.
4. Skewed Implied Volatilities (IVs) and Historical Volatilities (HVs): IVs and HVs have deviated further from realized volatility, making it more challenging to accurately gauge option pricing.
5. Erratic Option Premium Behavior: Option premiums have become more erratic, experiencing frequent spikes and causing stop-losses to be triggered more often.

Recommendations for Managing 0dte Options Trading:

To effectively navigate the 0dte options trading landscape, consider these strategies:

1. Diversify across multiple expiries, including current week, next week, and monthly expiries, to mitigate gamma risk.
2. Employ limited risk positional strategies like iron flies and iron condors on higher time frames and longer expiries for more stability.
3. Balance 0dte option selling with uncorrelated 0dte option buying strategies, allocating capital according to your risk tolerance.
4. Shift from time-based option selling strategies to wait-and-pause intraday option selling strategies to adapt to the dynamic market conditions.

Conclusion:

0dte options present a unique set of opportunities and challenges, demanding a comprehensive understanding of market dynamics, risk management, and strategic adaptation. By carefully considering the recommendations outlined above and staying informed about evolving market conditions, traders can navigate the 0dte options landscape with a greater likelihood of success.