Percentage of Options Expiring Worthless: Debunking a Myth

08/28/2015 8:00 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Though the argument that 90% of options expire worthless has often been bandied about, options expert Alan Ellman, of TheBlueCollarInvestor.com, points out that options traders have never heard such a thing from him and outlines exactly why this statement is simply not true.

“Selling covered call options and cash-secured puts is a smarter strategy than buying options because 90% of options expire worthless.“

We’ve all heard this argument but never from me because it is simply not accurate. The reason so many venues present this statement as truth is because only 10% of option contracts are exercised. That is true. But from there can we make the leap that 90% expire worthless?

If we did, we would be ignoring the 55%-60% of option contracts that are closed out prior to expiration. One of the key elements of the BCI methodology is mastering position management (exit strategies) where we buy back options. This information is detailed in my books and DVDs. Once we buy back an option it will not be exercised but neither will it expire worthless. The same holds true for a buyer of an option who then sells that option. Those options, too, will not be exercised nor will they expire worthless.

So, to be both informed and accurate—and according to the Chicago Board Options Exchange (CBOE)—here are the more accurate statistics:

  • 10% of option contracts are exercised
  • 55%-60% of option contracts are closed out prior to expiration
  • 30%-35% of option contracts expire worthless (out-of-the-money with no intrinsic value)

For put-sellers who do not want shares put to them and covered call writers who do not want their shares sold, the 30%-35% stat is still pretty impressive but it isn’t 90%. Now for conservative investors, is it better to be the seller of a decaying asset (theta or time value erosion eats away at option premium starting the moment we sell the option) rather than the buyer? In my view, yes it is, but certainly money can be made on the other side if option buying is mastered and if personal risk tolerance permits.

Other Reasons to Sell Options

  • Opportunity for monthly cash flow with high annualized returns using low-risk strategies
  • Appropriate for most market conditions
  • Generate income from your home computer
  • Compound profits in minutes as premium is in brokerage account immediately
  • Significant control via exit strategies
  • Downside protection as we start with an option credit
  • Covered call writers may also capture dividends
  • Opportunities to trade in self-directed IRA accounts, especially covered call writing

Disadvantages of Option-selling

The reason we have an opportunity to generate much higher than a risk free return (treasures for example) is because we are getting paid to undertake risk…low risk, but risk nonetheless:

  • Money can be lost is stock price dips below the breakeven
  • Profit potential is limited by the strike price
  • Assignment risk (may have to buy or sell shares)
  • There is a learning curve and time commitment (applies to most strategies that aspire to generate higher then risk-free returns)

Discussion

When evaluating which investment strategies are most appropriate for our families, we do our due diligence and evaluate all pros and cons. It is important that information is both accurate and properly understood so it can be meaningfully evaluated. The percentage of options that expire worthless is a meaningful statistic for option sellers, so we shouldn’t attach an inflated figure of 90% to it, but rather, the more accurate 55%-60%.

By Alan Ellman of TheBlueCollarInvestor.com

Related Articles on OPTIONS