‘Zero Days to Expiration’ Options: Investment or Gambling?

Researchers at the Univerity of Münster have found that a hot trend in short-term investments is causing traders to lose more money than they earn. Zero-days-to-expiration options (0DTEs) have become increasingly popular with retail investors. However, the study’s findings – released March 30, 2023 – raise the question of whether trading these products bears more resemblance to gambling than investment.

0DTEs are the shortest-term form of derivatives trading available. In a nutshell, they are effectively bets on whether the price of a stock will go up or down between the time of purchase of the 0DTE and the closing bell that day. Investors who take the wrong end of the bet will lose their money. Those who guess correctly can turn a profit in proportion to how much the stock price rises or falls.

The study’s authors – Heiner Beckmeyer, Nicole Branger, and Leander Gayda – make no bones about their opinion of the products, giving their paper the pointed title Retail Traders Love 0DTE Options… But Should They?

The researchers begin by pointing out just how quickly interest in 0DTEs has grown since early 2020. From there, they examine how much retail investors are losing by trading in those options and whether they are making informed decisions. The abstract reads, in part:

Almost the entire growth of trading in S&P 500 index options can be traced back to demand for 0DTE options [and] more than 75% of [retail investors’] trades in S&P 500 options today are in 0DTE contracts. Between February 2021 and February 2023, retail investors lost $184,000 on the average day; since the introduction of a daily expiration calendar in May of 2022, this number has grown to average losses of $358,000 per day.

To put that number in perspective, it’s roughly the same amount the population of West Virginia was losing daily at online casinos in September 2022.
Beckmeyer, Branger & Gayda show how the popularity of zero-day options exploded in 2020.

What are Zero-Days-to-Expiration Options?

Stock options are a type of contract. The party issuing the option guarantees the buyer either the right to buy or sell a particular stock at a specific price at any time before the option’s expiration date.

For instance, instead of selling your shares at $10 today, you could pay for the privilege of selling them for that price any time this week. If the price drops, you’ll want to exercise that option to sell your shares for more than the market value. (In practice, you don’t even need to hold the shares in the first place. You can buy the options and, if you want to exercise them, proceed to buy the stock at market value and sell it immediately for a profit.)

0DTEs are options that expire the same day they’re issued. That is, the buyer is only locking in their price until the relevant stock exchange closes for the day.

Options, like other derivatives, exist in principle for reasons of market efficiency and to allow hedging against risk. Ironically, they simultaneously provide the opportunity for high-risk speculation and can contribute to market volatility when abused. This becomes increasingly true the shorter the contract duration, with 0DTEs being the extreme example.

The reason for this is that options trading allows for high leverage. It’s cheaper to buy an option on a share than to buy the share itself. So, an investor can use options to speculate on a higher volume of shares for the same amount of capital. The downside is that if the stock moves in the wrong direction (or doesn’t move at all), the result is a 100% loss.

If Retail Investors Lose Money on 0DTEs, Who’s Winning?

It’s not surprising that retail investors, on the whole, lose money trading 0DTEs. Unlike the stocks themselves, stock options are not a positive-sum game.

The price of individual stocks can increase or decrease, but the market grows over time on average. Therefore, the average stock owner also profits over time. 

But options are like bets in that each exchange has a winner and a loser. If one person buys shares at $8 and uses an option to sell them at $10, that $2 profit comes directly out of the pocket of the person who committed to buying them at that price.

You’ll usually hear it said that options are a zero-sum game for that reason. However, they’re really a negative-sum game for the same reason poker is: even though it’s zero-sum between the players, there’s someone else taking a cut of the pot. In poker, that’s the rake. In options trading, it’s the transaction fees charged by financial institutions.

The University of Münster study found that retail investors lost $70 million on aggregate during the study period of roughly two years.

Of that, about $50 million (71%) can be attributed to transaction costs. That money is going to financial institutions and retail trading platforms.

The remaining $20 million is because of what the study calls “poor positioning,” which is another way of saying that retail investors take the wrong end of the bet more often than not. That money is going to institutional investors who are making better decisions.

The Paradox of Risk Affinity

The human urge to gamble is a bit of a puzzle for economists. When the goal is just to maximize money, a lower-risk investment is better than a high-risk one, given the same rate of return. In many cases, humans intuitively display risk aversion for the same reason.

And yet, at other times, people seem to gravitate toward risk even though it seems irrational. In this case, we see that the urge can be strong enough that investors are willing to accept a negative expected return in exchange for high volatility. That’s precisely the opposite of what traditional economic psychology would tell us to expect.

But it is, of course, exactly why people play slot machines or buy lottery tickets. The study’s authors go so far as to describe 0DTE and similar products as lottery-like assets. Indeed, the main place retail investors gather to discuss 0DTEs online is a Reddit forum with the telling name Wall Street Bets, and the boom in popularity of 0DTEs coincides with the interruption of sports betting by COVID-19 in 2020.

Economists have proposed various explanations, ranging from simple ignorance or thrill-seeking to more complex and counter-intuitive theories.

Trading Platforms Have Faced Regulatory Pushback

Financial regulators are aware of the risk such products pose to investors.

The popularity of gambling-like derivatives has risen alongside that of easy-to-use, self-directed trading platforms for retail investors on a budget. These include apps like Robinhood, which launched in 2015 but became a household name in the early days of the pandemic. Google Trends shows that the search volume for that app roughly quintupled just as the stock market crashed and sports betting ground to a halt.

In December 2020, Massachusetts regulators filed a complaint against Robinhood. They accused it of targeting inexperienced investors and preying on them with “gamification” marketing strategies to encourage trading in high-risk derivatives.

That legal battle is ongoing. Robinhood won the first round, with Superior Court Judge Michael Ricciuti ruling in March 2022 that the regulatory rule underlying the case was at odds with state law. The state appealed, however, and the case is now before the state’s Supreme Court, which heard the first round of arguments on May 3, 2023.

Robinhood isn’t alone in facing pushback over high-risk products. IG Markets is defending a class action in Australia on similar grounds. The suit, which got underway in October 2022, relates to contracts for difference (CFDs). These are like options in that they amount to bets on how a stock’s price will move. However, they have no fixed expiration date and are direct agreements between an investor and a brokerage rather than securities that can be traded on an open market.

The Problem With Investment-Based Gambling

The study’s authors feel that retail trading of 0DTEs is a lousy idea because investors lose money on average. However, there are good arguments for letting adults gamble if that’s what they want to do.

But even from a pro-gambling perspective, it’s worrisome that investors are using the stock market like a casino. It has many of the same problems that unregulated online gambling has:

  • In many states, the minimum age for options trading is 18, compared to 21 for casino gaming.
  • Retail trading platforms don’t have the same responsible gambling features as regulated online casinos.
  • Although stock markets have regulatory oversight, the focus isn’t on curbing addiction because gambling isn’t the intended purpose.
  • Self-deception contributes to gambling addiction, so gambling products disguised as something else are particularly risky.

As the US wrestles with the question of online gambling regulation, it may be worth looking closely at the laws around 0DTEs and other products that seem to scratch the same itch.

About the Author

Alex Weldon

Alex Weldon

Alex Weldon is an online gambling industry analyst with nearly ten years of experience. He currently serves as Casino News Managing Editor for Bonus.com, part of the Catena Media Network. Other gambling news sites he has contributed to include PlayUSA and Online Poker Report, and his writing has been cited in The Atlantic.
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