Navigating the World of Short-Term Index Options

In a world where news and market-moving events are streamed in real time, traders are often in pursuit of opportunities that align with shorter time horizons and risk appetite. Shorter-dated options, especially those that range from zero (0DTE) to five days to expiration, are instruments that amplify both the potential for high returns and the level of risk. These unique options, when traded as European-style index options over their ETF counterparts, can offer advantages such as cash settlement and favorable tax considerations. Additionally, the introduction of the micro-sized Nasdaq-100 index options (XND) allow retail investors to harness the same benefits with more flexibility on size.

In this post, we'll explore the nuances of shorter dated, 0DTE European-style index options and discuss why they may be an attractive choice for traders seeking a specific risk-reward profile.

What advantages do index options provide for 0DTE strategies?

One of the most significant advantages of index options over ETFs is cash settlement. This is particularly beneficial for sellers of 0DTE options who prefer removing the risk of potential assignment across the frequent expirations. European cash-settled index options contracts are settled in cash rather than the delivery of physical shares. This mechanism is especially advantageous for shorter dated options where it favors sellers as 'Theta,' the time decay of options, accelerates. Sellers of these short dated 0DTE options can exploit this time decay acceleration, while removing the complexities and margin requirement risks with physical settlement each day.

What tax benefits do index options provide?

When it comes to taxation, index options benefit from a unique provision. Under Section 1256 of the U.S. Tax Code, they enjoy a mixed tax treatment that often results in a lower tax liability compared to trading similar shorter dated options on ETFs. This favorable tax treatment can serve as a partial counterbalance to the risks associated with short-dated options, offering a tax-efficient path for investors trading 0DTE options contracts.

Which Index Options are suitable for retail traders?

One of the challenges of trading the Nasdaq-100 Index Options is its size. Currently priced at over $15,000, each contract carries a notional value of over $1.5 million, making it suitable mostly for large and institutional investors. However, with XND, the 1/100th Nasdaq-100 Index Option allows retail traders to harness the Nasdaq-100's potential while providing flexibility in exposure. These options open the doors of index options with contract sizes that are just over $15,000 per contract, or about a third of the size of QQQ ETF options.

Higher Yield Potential with the Nasdaq-100

A key factor in trading shorter-dated options on the Nasdaq-100 is the higher premiums or yield that can be collected compared to other indexes such as the S&P 500. For example, comparing a 1 DTE, 30 Delta Put on NDX vs. SPX on November 9 @ 1:30 PM EST, NDX put options yielded nearly 20 bps, versus 14 bps for the S&P 500, a 42% higher yield. This potential for higher yield provides the sole source of potential gain for sellers of shorted dated options, as the elevated volatility of the Nasdaq-100 improves the risk-reward ratio.

Short Dated Options Yield Comparison

In summary, trading 0DTE European-style index options is a strategy that speaks to investors with a willingness to embrace intraday volatility for the potential of higher returns. While the tax benefits and micro-sized index options like XND make trading 0DTE options more accessible, the cash settlement of index options makes it far more advantageous over similar ETF options. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Tony Zhang

Tony Zhang is a specialist in the financial services industry with over a decade of experience spanning product development, research and market strategist roles across equities, foreign exchange and derivatives. As the current Chief Strategist for OptionsPlay, Tony currently leads the research and development of their OptionsPlay Ideas & Portfolio platform. He has leveraged his interest in financial technology and product development to provide innovative reimagined solutions to clients and the users they seek to serve. Previously, he spent 7 years at FOREX.com with a capital markets and research background as a market strategist specializing in equity and FX derivatives markets.

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