Tom posted his comments to my option trading blog – “The Problem with Debit Spreads” and he inspired this piece. He states that he’s heard people say that 80% of all options expire worthless and they should never be bought. He also says that claims are being made that option sellers are the only ones making money and they make money 80% of the time. I’ve heard the same numbers thrown around for years and I can’t wait to comment.
First of all let’s qualify that statement. For every listed call, there’s a listed put. One of the two will finish in the money and one will expire worthless (except for the case where a stock gets pinned and finishes right at the strike). Clearly this 80% statistic must refer to open interest (open option positions).
Out-of-the-money (OTM) options are much cheaper than in-the-money (ITM) options and you can assume that in terms of shear numbers, there are many more out of the money options traded. Take an example where a trader thinks a stock is going to $56 so he buys a $50 call for $3.50 when the stock is at $53. Another trader with the same opinion decides that he can double his money with the $55 calls so he buys 7 of them for $.50. The stock closes at $55. In this instance 88% of the options expired worthless but 50% of the premium buyers made money. The number would carry more meaning if it were dollar weighted. The “educators” pumping premium selling choose to spin this story in a misleading way.
Another point to be made is the multi-dimensional way in which options are used. If I’m a large mutual fund and I buy OTM puts by the tens of thousands to hedge risk, do I care that they expire – no. They have served they’re purpose and that insurance premium never had to be used. This event has a huge impact on the 80% number and it needs to be considered in the right context. This was not Joe retail playing “take a shot – make a lot”…. the sky is falling and I’m going to get rich. This was a calculated move that helped the fund achieve its investment objectives.
The implied volatility (IV) of the options needs to be taken into account before a selling strategy can be considered. Think of what would happen if everyone would just sell options. The premium would go down to the point to where the risk/reward would stop making sense. The historical volatility of the underlying and news events (uncertainty) must be accounted for. Until a few weeks ago, the IV’s as measured by the VIX were at historical lows and you were not being well rewarded for the risk. Premium sellers tend to favor puts (most retail option accounts are not approved for naked call writing), how do you think they’ve weathered the quick 5% market drop.
Let’s say I sold puts on a stock from January through May. In the first four months I made $.80 each month and in May I had to buy them back for $5. In this scenario 80% of the options I sold expired worthless, but I lost money overall.
As for who makes more money, the person who forecasts the move of the underlying more accurately and structures their option strategy accordingly. There is not a one size fits all option strategy that consistently makes money. That’s the beauty of options. The conditions are always changing and if you can determine the nature of the beast, you can tailor fit a strategy around your opinion and risk profile.
Thanks for the comment Tom. Send me an e-mail at [email protected] and let’s see if we can hook you up for a free month to one of my services.