0 Day Degeneracy?

Good Morning!

This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!

And even if you don't trade, learning how to think like a trader builds a robust framework for problem solving, taking risks, managing a plan, and just living life.

Quote of the day:

"It's my money, and I need it now!"

So sad! These are faces of desperation. When I successfully pull off a "slip-n-fall" at McDonalds, I want my money and I want it now!

Back in the day, you had to call your boy, J.G. Wentworth, to get paid out on your structured settlement. But nowadays, all you gotta do is structure a trade using 0 day options! 

In the world of options trading, 0 DTE options can help you efficiently bet on intraday SPX moves (read this as: you will gain OR lose money expeditiously). But before we dive into that, let's first define what DTE stands for. DTE stands for "days to expiration," and it simply refers to the number of days remaining until the option contract expires.

When an option has 0 DTE, it means that it will expire on the same day that you're trading it. This is where the term "degeneracy" comes in - because when you're trading options with almost no optionality left (there is some and we'll get to that). You're essentially gambling on the intraday moves of the SPX.  (Refresher on SPX)

Now, before you dismiss this strategy as reckless and irresponsible, hear us out. If you want to bet on the market going up or down intraday, 0DTE can be better than futures/stock trading for many reasons:

• built-in stop-losses

• asymmetric payoffs and premium capture

• more ways to manage directional risk

• the ability to make custom bets

• lower capital requirements

• they pay out at the end of every day

If that doesn't "wet your beak", I don't know what will!

BANG for Your Buck:

4000 level: 

Dealers are net long the 4000 strike. This should act as resistance or tiny gravitation field, which helps decrease volatility near there. Pops over get sold and breaks lower get bought. Remember, this gravity is localized and not that strong, so the market has to be close enough to 4000 for it to work.

If you are looking for a rally to the 4100s, you probably need to wait for a catalyst to reprice the market away from 4000 such as Feb 1st FOMC.

3900 level: 

Dealers are net short the 3900 strike.  A break below opens the door for expanded volatility and easier extension of a selloff. Recap of short option hedging.

Why Trade SPX 0DTE Options?

First off, who is using these puppies? Surprisingly, 95% of the volume is pro traders not "retail". Why is that?

No overnight risk

These bets expire at the end of every day. You don't get assigned a futures contract that you have to roll out of, you get cold hard cash sent to your brokerage account!

Minimal capital usage

A futures contract requires margin, and buying stock has no multiplier so you need to use a lot more capital to achieve the same profitability.

Example: ES future margin is currently $10,600 (even intraday at certain brokers is still $500) Out of the money SPX 0DTE options costs range from a couple hundo to a couple gs, at best! 

Built-in stop-loss

If you buy an option, you are only risking what you paid for it.

No need to exit the trade. If the market runs in your favor, let it expire. If it goes against you, let it expire. There is no slippage, no extra commission, etc.

Asymmetric Payoffs

As I said above, if you buy an option, you only risk what you paid...but your potential profit can be unlimited! And here's the kicker: if you buy a near out-of-the-money option, and the market goes in your favor, the option value will increase faster than the market (geek speak: long gamma / long convexity)

Trading a stock or a futures contract is 1 to 1 upside to downside.

Yes, this "optionality" does come at a cost...which is our next benefit!

Premium Capture

These puppies lose all their "time value" TODAY! 

Here's the worst-case scenario if you sell a 0DTE option: you get the exact same exposure as being long or short a futures contract!

Oh, but you get to collect the premium, so you entered into your futures contract at a discount!

If you're willing to trade futures, you should be selling calls and puts on 0DTEs.

Flexible Management and Bespoke Bets

1. You can get long and short the underlying market. With stocks, it's not always easy to short

2. You can roll out of long option and directional exposure by selling other options against it!

   1. This allows you to capitalize on both "asymmetric payoffs" (pro speak: long convexity) and also "collecting option premiums" (pro speak: short premium)

Or let's say you only want to buy the underlying if the market breaches a key technical level. In your mind, the market will accelerate to the updside.

No need to "stop yourself into the market" or set up alerts, why not just sell a call at the key level and buy 2 calls higher. If the market truly takes off, you are long right when you need to be. If the market just flirts with that level, you financed your bet by collecting premium (there is more risk if it breaches but does continue strongly, but that's a topic for another day)

Don't worry if you don't understand all of what I wrote here. Next week, we will dive into specific use cases and examples of the 0DTE.

As always, pursue the process NOT the profits! See you tomorrow!