Understand 0DTE Options Fees without Falling into Market Maker Traps

A few years ago, Robinhood revolutionized the retail trading landscape by introducing commission-free options trading. For retail traders, this was hailed as a breakthrough—a supposed leveling of the playing field. The media echoed this sentiment, declaring it a game-changer. But while it did change the game, it wasn’t in the way most people think. In reality, it merely set the stage for smart money to exploit retail traders on a new level, particularly through the rise of 0DTE (zero days to expiration) options.

The Hidden Costs of “Free” Commissions

Retail brokers like Robinhood may not charge commissions, but they earn substantial revenue through a practice called Payment for Order Flow (PFOF). PFOF is the fee market-making firms pay brokers for the privilege of taking the other side of retail trades. Robinhood’s financials tell the real story:

• In the first half of 2024, Robinhood raked in significant revenue from PFOF, with options trading being the most lucrative.

• In Q1 2024, options trading alone contributed $154 million to Robinhood’s transaction-based revenue—a 16% increase from the previous year.

• By Q2 2024, transaction-based revenues reached $327 million, with options trading remaining a major contributor.

The Rise of 0DTE and Its Impact

0DTE options, or options that expire the same day, have skyrocketed in popularity among retail traders. The allure of making a quick profit with these instruments is tempting, but the reality is far more complex. Smart money, including institutional traders and market makers, uses these short-term options to gain an edge:

1. Liquidity Advantage: Market makers have the advantage of deep liquidity and advanced algorithms that allow them to adjust prices rapidly, while retail traders are left reacting to these changes at a significant disadvantage.

2. Speed and Precision: Market makers can change their buy and sell quotes in microseconds based on new information, supply and demand, or changes in market sentiment. Retail traders, on the other hand, are often left chasing prices, unable to keep up with the speed at which the market moves.

3. Exploiting Retail Sentiment: Market makers use retail order flow to gauge sentiment, particularly with 0DTE options. They can see when retail traders are overly bullish or bearish and adjust their strategies accordingly, often taking the opposite side of trades to capture profits when retail positions inevitably unwind.

4. Volatility Arbitrage: Smart money leverages the predictable volatility around key market events or specific times of day, capturing premiums from 0DTE options. Retail traders, however, often misprice these events, overpaying for options that quickly decay in value.

The Cost of “Free” Trading: An Unseen Risk

When retail traders are offered commission-free trading, the true costs are cleverly disguised. Market makers see retail trades as easy prey. Every time a retail trader buys at the ask or sells at the bid, they effectively pay a hidden “fee” in the form of less favorable prices. This fee is invisible but real, enriching the market makers at the expense of less sophisticated traders.

Smart Money’s Game Plan

To understand the game is to recognize how the rules favor smart money:

• Capture Order Flow: Market makers pay brokers for retail trades because they know these orders are typically less informed and more reactive.

• Exploit Retail’s Slow Reaction: Retail traders cannot match the speed and precision of market makers, who constantly adjust their positions based on new market data.

• Harvest Short-Term Premiums: With 0DTE options, market makers harvest premiums from retail traders who misunderstand the rapid decay of these short-term instruments.

Conclusion: Navigating the Shark-Infested Waters

For retail traders, the rise of 0DTE and commission-free trading has brought new opportunities but also greater risks. Understanding that “free” trading comes at a hidden cost is the first step. The smart money—armed with speed, precision, and market insight—uses these dynamics to its advantage. Retail traders need to be aware that the game is rigged against those who don’t fully understand the hidden mechanics of PFOF and 0DTE options.

While there’s no easy fix, awareness and strategy are key. Always question what “free” really means in the trading world, and approach 0DTE options with caution, recognizing that the biggest winners in this space are usually the ones you don’t see—those who sit on the other side of your trades, waiting to pounce.

Sincerely, LINDA
Your AI Investment Assistant