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0DTE options are unique options that expire on the same day they are traded. They are available for indexes such as the S&P 500 or the Nasdaq 100, or highly liquid stocks like Apple or Tesla.Spencer Platt/Getty Images

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Investors are constantly looking for ways to outperform the market – to make outsized returns without taking on undue risk. For some, that has meant dabbling in options trading.

In the past year or so, there has been a surge in activity in the options market from retail traders looking for ways to profit from short-term price movements and volatility. One of the most popular strategies is to trade options that expire within a day, also known as zero-day-to-expiry (0DTE) options.

0DTE options now make up half of all S&P 500 options trading activity, according to JPMorgan Chase & Co. But these strategies are among the riskiest in the investing world.

Not many advisors are willing to work with clients to help them dip their toes in zero-day options trading. However, there are lower-risk ways to benefit from the trend.

The first step in understanding zero-day options trading is getting a grasp on some of the underlying concepts. Options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price and time. The seller of the option, also known as the writer, receives a premium from the buyer in exchange for taking on the risk of fulfilling the contract if the buyer exercises it.

Options have different expiration dates, ranging from weekly and monthly to quarterly. 0DTE options are unique options that expire on the same day they’re traded. They are available for indexes such as the S&P 500 or the Nasdaq 100, or highly liquid stocks like Apple Inc. AAPL-Q or Tesla Inc. TSLA-Q.

0DTE options are attractive to retail traders for several reasons. First, they offer a high-leverage effect, meaning that a small amount of money can control a large amount of exposure to the underlying asset. They also have a low cost of entry, as the premiums are typically cheap due to the short time value.

They also allow traders to capitalize on intraday price movements and volatility spikes, which can be driven by news events, earnings reports, or market sentiment.

“It’s a great way to protect and hedge your portfolio,” says John Christofilos, senior vice president and chief trading officer at AGF Investments Inc. in Toronto.

“If you have a view on a very short-term move in the market, you can use these zero-day options as a hedge against the impact of a certain event.”

It could be an earnings report, protecting the investor against the stock going one way or another, he adds.

Advisors reluctant to use zero-day options

However, Mr. Christofilos has concerns as well and worries not enough people understand the impact zero-day options can have on a portfolio.

“They expire at the end of the day. They can expire worthless, and whatever you put in is gone at the end of the day if it doesn’t go your way,” he says.

“There are very few investments in the world [in which] you can lose all your money in one day. Everyone wants to learn, and the best way to learn is when you lose your money.”

Most Canadian investment advisors are also reluctant to add 0DTE options trading to the strategies they offer their clients.

Chris Thom, president and portfolio manager at Moat Financial Ltd. in Vancouver, does see the attractive side.

“Zero-day options have a short timeline, lower cash outlay and higher leverage,” he says. “Those are all attractive things if you are trying to ‘get rich quick,’ but if you get it wrong, you can lose a lot of money very fast.”

In trading these options, the investor needs to get the market direction, amplitude and timing right, which is easier said than done, he adds. The cost of these strategies can also be high as commissions add up.

Despite having experience trading options, Mr. Thom says zero-day options are not something he uses for clients.

“I would put it a notch higher than speculative and consider it gambling, which doesn’t align with our risk tolerance or values,” he says.

A lower-risk way to benefit from the zero-day trading trend is through an exchange-traded fund (ETF).

Defiance ETFs LLC, a thematic fund company based in Miami, has recently launched two funds that utilize 0DTE trading – Defiance Nasdaq 100 Enhanced Option Income ETF QQQY-Q and Defiance S&P 500 Enhanced Option Income ETF JEPY-A.

“We believed that selling 0DTE options could provide enhanced income for investors looking for outsized yield, and willing to take on the same risks as the underlying index,” says Sylvia Jablonski, chief executive officer and chief investment officer at Defiance ETFs.

“The potential income from these funds could prove to be the top yielding within the ETF marketplace.”

Indeed, the funds have paid out an eye-popping annualized return of 67.5 per cent and 55 percent for their first distributions. They have attracted more than US$100-million in combined assets in less than a month.

Some market observers are concerned that the proliferation of 0DTE options could lead to increased systemic risk – the chance for a serious market event such as the “flash crash” of 2010.

In a recent blog posting, AGF’s Mr. Christofilos detailed a scenario in which a big move in market prices may push short-term options well “into the money,” leaving sellers unable to support their positions. In turn, this may lead to forced covering that could result in intraday selling or buying worth as much as US$30-billion.

“Anytime a lot of money flows to one asset class, it doesn’t end well,” he says.

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