Popular belief: 80-90% of options expire worthless therefore it is better off being a net seller than a net buyer of options at any time.
How many times have you read this? I know I have read or heard it dozens of times. “80% of options expire worthless therefore it is better to be an option seller”. I trade these things for a living and this statement has confused me. My first thought was how can it be possible? If you consider that at any one time about 50% of all options are in-the-money and 50% are out-of-the-money, and only out-of-the-money options can expire worthless, then could not the figure be closer to 50%?
In the book Options on Futures by Summa and Lubow, they quote the 80% figure and it is backed up by numbers from the Chicago Mercantile Exchange (CME). In a section entitled “The Numbers Speak for Themselves”, they show a table of data sourced from the CME. The numbers represent the percentage of options that expire worthless. The data from the book is as follows:
Year | CME options | S&P options | S&P puts | S&P calls |
1997 | 76.3 | 81.7 | 94.1 | 54.8 |
1998 | 75.8 | 82.2 | 93.1 | 43.9 |
1999 | 77.5 | 84.7 | 94.5 | 66.7 |
1997-9 | 76.6 | 83.3 | 94.0 | 55.3 |
Assuming we have no reason the doubt these statistics, then this seems to back up the popular belief. On careful reading however, it appears the figures represent only those options that are held to expiration and not those that are closed out OR exercised before expiration (remember we are dealing with American style options here). So maybe we do not have the whole picture...
Recently I also came across some more stats from the Chicago Board Options Exchange (CBOE) that I thought were interesting. Their figures are:
· Approximately 10% of options are exercised;
· 50-60% of options positions are closed prior to expiration;
· The remaining (about 30 – 40%) are held to expiry.
At first these figures might look rather contradictory, but they are not. The CME numbers are based on options that are held to expiry. That is they do not include options that are exercised or closed before expiry – and that’s 60-70% of all options according to the CBOE. If we take both exchange’s statistics as fact, then drawing a conclusion from only the expiry numbers could be a bit biased. It would be like taking a test drive in just one car and assuming all other cars are the same
Think about the CBOE numbers for a moment. The 10% that are exercised early would in all but very rare cases be in-the-money. If we assume therefore that only in-the-money options are exercised, then this would leave more out-of-the-money options heading to expiry than in-the-money.
What about the options that are closed before expiry? I would hazard a guess that most options closed near expiry would be either in-the-money, at-the-money or just out-of-the-money.
Why? in-the-money options will behave more and more like the underlying the deeper they are in-the-money and the closer it gets to expiration. Holding in-the-money options therefore will carry more risk. This could be a reason why some holders may want to close their in-the-money positions prior to expiration. Out-of-the-money options on the other hand may be worth very little and hold little risk (low delta). Therefore you might say there is larger chance of out-of-the-money options being held until expiration.
Therefore, the 50%-60% of options that the CBOE claim are closed before expiration could also be weighted towards in-the-money options. This being the case, the majority of the 30-40% that go on to expiry would therefore be out-of-the-money and of course would expire worthless like out-of-the-money options do. Does that mean you should be a net seller though?
Let’s play with some numbers. Let’s say we have an exchange with 1,000 open option contracts. 10% of the options (all in-the-money) are exercised early leaving 400 in-the-money and 500 out-of-the-money. Then 60% of the total pool are closed out. Then let’s assume three quarters of these are in-the-money and one quarter is out-of-the-money.
| In-the-money | Out-of-the-money |
| 500 or 50% | 500 or 50% |
Early exercise (10%) | 100 | 0 |
Remaining | 400 or 44% | 500 or 56% |
Closed positions (60%) | 300 | 125 |
Option to trade to expiry | 100 or 21% | 375 or 79%! |
That would leave 100 in-the-money options and 375 out of the money options that will run until expiration. (see table). Based on the one assumption above, close to 80% of the options that will go to expiry are out-of-the-money and therefore will expire worthless.
So the figures do make sense. Perhaps 80% of options that run to expiry do expire worthless. However that is not the same as saying 80% of ALL options expire worthless. Can you see the difference? Furthermore, coming to the conclusion that is it better to be a seller than a buyer from a single biased statistic like this is plain nonsense.
In a topic such as options trading, it is easy to get caught up with statistics, but if we take the time to think and research before drawing conclusions, then surely we will become better traders.
I came across a book called The Options Edge by William Gallacher. This book addressed the same issue and spends a great deal of time testing the concept of whether or not a seller has the advantage. The outcome of his tests was that there is a very slight edge for the seller – very slight. These tests however take into account several assumptions, some of which you may not even agree with. (By the way it’s a good book to read simply to see the detail that goes into testing this concept.)
The point is blindly selling options is not applicable to all market circumstances. The trick is to know to when this strategy is appropriate. Or as Kenny Rogers would say: ”you have to know when to hold ‘em and know when to fold ‘em”.
A good trader would have a method by which you can identify the right time and more importantly the wrong time to trade this strategy. That may involve technical analysis or probability analysis or more popular is the concept of understanding volatility.
Author Guy Bower is professional futures and options trader. Guy is the author of two books: Options: A Complete Guide and Hedging: Simple Strategies. |
