Zero Days to Expiration Options: Daily Butterfly Options Strategies
Mar 20, 2023
When we look at trading these zero DTE options that everyone is talking about, we must consider the following question: what exactly are we trading? It sounds like a silly question since we just discussed what we are trading (zero DTE), but the actual exposure that you could have on using the zero DTEs varies wildly with the strategy you choose. In fact, the combination of zero DTE options have more risk combinations than longer term options. Butterflies are strategies that are rarely used for longer dated options because of their slow momentum and change until the very last days of the expiration cycle. This makes them worthwhile candidates to consider when trading zero DTE. Butterflies eliminate all of the risk inherent to both naked long and naked short options in the zero DTE cycle.
Remember that naked long options are susceptible to extreme decay throughout the day because they expire at 3pm whereas naked short options are exposed to huge tail risk as a multiple of the credit received if there is a large intraday move. Both of these risks make naked zero DTE options a tough trade for retail traders. In fact, when adjusting for time, zero DTE options can have nearly 6x the premium that 45 DTE options have, meaning the risk is at least 6x greater to trade them for the same dollar of premium paid or collected. Since butterflies consist of both long and short zero DTE options, the excessive risk is canceled out. You are left with a strategy that is designed to trade the intraday range.
The beauty of this butterfly trade is that regardless of the volatility in the market, the price of the butterfly doesn’t imply that there is more or less premium drag or tail risk…higher volatility days mean that butterflies are cheaper, so the max profit on a single butterfly goes up because there is a lower chance it stays in the range. The reverse is true for lower volatility days.
A trade idea for these range-bound butterflies is to scalp some % of debit paid within a few hours of the day. Because butterflies are not inherently long or short premium trades, the chance of making money on a butterfly is dependent only on the amount you wish to make, and not on the implied volatility or expected move on the day. For example: if you want to make 50% on a butterfly, you would have a 67% probability of doing so regardless of what the expected move is.
Butterflies are an efficient way to trade daily ranges using zero DTE options without incurring any of the excess risk that is normally associated with trading that timeframe.
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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