What is 0dte trading and how does it differ from other trading strategies?
Zero-DTE or DTE trading is the process of buying and selling options contracts on the day of expiration. We plan to open and close our position on the same day and on the expiration day of our contracts. This will require us to make a day trade and could flag us as a pattern day trader if we trade more often than 3 times a week. Ideally, we would like to be in and out of the trade in about an hour. The longer we stay in the market the more risk we have of a trend developing. We also avoid overnight risk because we are in and out of the market on the same day. Both SPX and SPY offer option expiration dates 5 days a week so this trade could be entered every day.
Risk vs reward
The risk reward in 0dte can be very high. We can earn 4-10% on our buying power in less than an hour. But on the flip side we can lose 10-20% if our stoploss is hit. Risk- Reward is typically between 2 or 3 to 1. A stop loss of 60 and a profit target of 20 would equal a risk reward of 3 to 1. Position sizing can become very important. A profit target of 20 can usually be achieved in as little as 20 minutes but on average in under an hour. A profit target of 40 can be achieved in 2-2.5 hours. More time in the market equals more risk. A stop loss of 60 and profit target of 30 is a good balance and gives a 2 to 1 risk reward. If using SPX, I use 200 for the profit target and 600 for the stop loss.
79% win rate using only SPY and 2100 in buying power.
Positions sizing and capital requirements
This strategy can be done using very little capital. With a product like SPY we can get away with using as little as 400 dollars using spreads 4 points wide. The same trade in SPX would use about 4000 dollars using 40 point wide spreads. It’s best to allocate between 2-5% position size equal to our stop loss. If account size is $3000 2% of total acct value would be $60. With a stoploss of 60 and a profit target of 20. We can enter 1 butterfly in SPY. If our spread width is 5 we would use 500 in buying power. If we reach our profit target of 20 this would represent a return of 4% on our buying power used and a gain of .67% on total acct value. If our stoploss gets hit it will be a loss of 12% on the buying power used and a loss of 2% on our total acct value. Adjust position size accordingly.
0dte Trend and Consolidation.
Timing and strategy
The strategy is to look at the market and determine if we are in a trending day or a consolidation day. A trending day can be bad because a move of 2-3 points in SPY and 20-30 points in SPX can stop us out. A consolidating range with little price action is the perfect scenario for our strategy. Much of the pricing action in the market occurs during the first 90 minutes and also the last 60 minutes. We look to enter in the middle part of the day while the market is calm. Before the open we will note the days expected move. At approximately 10:30 or 60 minutes after market open we will look at the opening range of price movement and compare it to the days expected move. If the expected move is +-3.0 and SPY has moved 5 from the days low to the days high it may be best to skip this trading day. But if SPY is trading in a range of only 1 we could have a relatively calm day. Also being aware of any major events and avoiding them is best. I always recommend skipping FOMC days. Most major news events like CPI and inflation are announced in the early part of the day so I try to avoid these also.
The IRON FLY
Entry
If we decide today is a good day to enter, we will sell the ATM (at the money) Iron Butterfly Spread. This consists of selling both the at the money call and put and buying wings for protection. Our wings can be anywhere from 4-to-10 points away in SPY. For SPX I use 40-to-100-point wide wings. Narrower wings will allow us to not get stopped out as soon but will also give less premium causing us to have to stay in the trade for a longer duration. Wider wings will give more credit but can stop out quicker. An example using SPY is wings 10-points wide may stop out at +- 2.60 move in SPY while wings 7-point wide wings may allow for a move of +-2.80 before getting stopped out. Sometimes this extra .20 can be the difference between a winning and losing trade. I try to position the width of the wings so that I stop out close to my break even point. This can be visualized in the analyze tab of Thinkorswim.
Exit criteria
Immediately after entry se will create an OCO (One Cancels the Other in Thinkorswim) order. We will set our profit target and our stop loss. This makes the trade very mechanical and helps to remove emotion from trading. We can also adjust our profit targets and stoploss after the fact. If I see the trade is going my way, I may increase my profit target to 25 or 30 but rarely go over 40. Or if I see the mood of the market change, I may decide to exit early for a small loss and wait to trade another day.
Volatility effects
Volatility can have a big effect on our position. A rise in volatility can also increase the value of our position and if you’re short options this can be a bad thing. Conversely if volatility drops it can help us achieve our profit targets quicker. A spike in Volatility can also cause the bid ask spread in our contracts to widen causing a stop out also.
Suitability
This strategy is not suitable for all. If your stoploss does not trigger you can have substantial losses. Also, because our contracts are 0dte they are heavily affected by the option greeks. Large swings in price will happen and price can swing from your stoploss to your profit target and vice versa in a matter of minutes. Having OCO orders (One Cancels the Other) can help us exit the trade at our defined profit and stop loss targets. One major positive for me is that we have zero overnight risk if we are opening and closing on the same day.
Practice makes perfect.
I recommend paper trade any new to you strategy first. This will give you the confidence to trade the strategy with real money. This also gives a good opportunity for trade management and setting up custom OCO orders.