Vertical Spreads in 0DTE Options
May 1, 2023
The key research findings that my team has found on the zero DTE options is the magnified risk and potential return per unit of capital deployed than longer-dated options. Trading vertical spreads is no exception to this rule.
When trading zero DTE options, one will notice the magnified swings of the positions despite the lower price paid (or received if selling) the options.
We like to compare the risk return of zero DTE options with that of 45 day options. We tend to trade 45 day options as our default duration due to a manageable and sustainable risk profile that can also provide decent returns.
When comparing the risk/return of zero DTE short vertical put spreads, that is selling one out-of-the-money put and buying one further OTM put, we find that the exposure of the zero DTE options is roughly 10x greater than the 45 day put spreads when comparing the swings as a % of credit received.
Acknowledging that the 45 day put spreads are roughly 8x more expensive than the zero DTE put spreads, it turns out that one contract of the zero DTE actually carries around the same risk as one contract in the longer dated cycle!
Because the gamma risk (exposure) on the zero DTE options is greatly magnified relative to the amount of capital deployed, when normalizing for the cheaper overall price of the option, you actually get a dollar-for-dollar risk profile that is similar on a day to day basis.
This reinforces the power of options and being able to use different strategies that are more capital efficient, yet achieve a similar risk profile. Let’s take a look at a table below that corroborates this:
|SPY||P/L of Short Put Spread|
|Zero DTE||45 DTE|
When looking at the changes of the position profit and loss given a certain move in the underlying stock, we see that the zero DTE spreads have roughly 10x the exposure as a % of credit received than the equivalent 45 day spread.
|SPY Short Put Vertical||Average Net Credit for Short 35 Delta and Long 25 Delta|
Notice that the credit received for the longer dated spread is roughly 8x that of the zero DTE spread. When taking both those factors into account, the actual dollar risk is actually the same despite the stark differences in the duration and position.
Understanding how to compare and contract risk and return as an options trader will allow you to utilize strategies that are the most effective for your unique financial picture and goals.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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