Capital Efficiency For Zero DTE Positions
Zero DTE options come with the allure of turning a small amount of money into a fortune over the course of one trading day. Because of their low priced relative to longer dated options, 0DTE option volume has approached $1 trillion in notional per day.
As we continue to uncover more and more research on this part of the options markets, it's important to talk about some inherent inefficiencies so that retail traders can navigate around that.
Breaking Down Capital Efficiency for Zero DTE Options
On this week's research piece on the zero DTE options, we talked about the capital requirements to trade them. When we trade options in longer dated cycles, we discuss trading undefined risk short options.
The key feature of those positions is the capital requirement and its calculation. A rule of thumb to determine how much capital an undefined risk, short options position carries is the following: between 15 and 20% of the underlying stock price, with a larger capital requirements correlated to how close the option is to the stock price currently.
Since this formula does not take the duration of the option into account at all, what we find is that the capital requirement for naked undefined risk short option positions in short dated options is actually significantly higher than the same position in the longer dates options. In fact, a short strangle in the zero DTE options required roughly 10% more capital than the same position in a 45 day cycle.
Conversely, a defined risk position (where are you cover the exposure of the short options with a further out of the money long option) actually required nearly 80% less capital in the shorter dated options than the longer dated options.
How to Maximize 0DTE Options Profits
In fact, when we studied the entire options chain, we found that adding a long option to your short option position in the zero day cycle would result in roughly 80% less capital than an undefined risk position regardless of how expensive that long option is.
This means nearly all positions in the zero DTE cycle would benefit from a long option where risk is defined solely because the amount of capital required is 80% lower than not adding that long option.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.