Do 90% of Options Expire Worthless?

Is it true that 90% of options expire worthless? If so, according to a popular argument, it proves that option sellers have the advantage over option buyers.

What a wonderful example of false logic. It leaves out the essential question, namely – how much do option sellers win on winning trades vs how much they lose on losing trades?

In other words, if you win a dollar 90% of the time – but lose $50 10% of the time, then you’re still a net loser.

The basic truth of being an option seller is well-known to every professional option trader. You will make money most of the time but get killed occasionally. And a one-time loss from a catastrophe can easily dwarf profits made over 10 years of steady markets.

I’ve seen it argued that you can make money selling options while hedging your risk. That’s like saying I can be paid for assuming risk yet actually take no risk. Doesn’t work. The myth of risk-free profits underlies such legendary blowouts as Long Term Capital, Bear Stearns, Lehman – the list goes on and on.

The truth is that no successful trader is either a 100% buyer of options or a 100% seller. The trick is to understand the market and do the right thing given current conditions. Sometimes that means being a buyer of options, sometimes a seller, sometimes a spreader. There’s no simple formula for success.

27 Responses to “Do 90% of Options Expire Worthless?”

  1. Kevin says:

    The definition of “worthless” is the real question here.

    About 50% of options expire in-the-money and about 50% expire out-of-the money. Makes sense…just look at an option chain on any given day.

    Do you consider an option that has expired in-the-money to be worthless?

    The “80-90% of options expire worthless” saying assumes that all options that have depleted their time value are considered worthless.

  2. jay shriber says:

    so isnt the best bet to sell opens that are as close to expiration as possible making it much more likely they will expire worthless?

  3. pepperstone says:

    pepperstone…

    [...]Do 90% of Options Expire Worthless? « Dean Mouscher's masteroptions.com[...]…

  4. Larry says:

    Dean,

    I am having difficulty understanding how your post applies to selling/writing covered calls. Where is the “losing trade” or “catastrophe”? Either you get called out or you don’t and either way you keep the premium. If called out you either keep a reduced premium when the strike price is below your basis or make additional money when the strike price is above your basis. If you start with a “good” stock, seems like the worst case is you are “stuck” with a good stock.

    Your comments would be appreciated. Keep up the good work!

    • Dean says:

      Remember, the purpose of the post is to point out that when you DO lose money selling options, you can lose a LOT of money. That’s true whether you sell naked calls or naked puts. It’s true for covered-call writers too, because a covered call is essentially the same as a naked short put.

      For example, let’s say IBM is at 165. For the sake of simplicity, we will assume that interest rates are zero (not too far from the truth) and IBM pays no dividend. So the price of the 165 call and the 165 put is identical – let’s say $3.00

      In scenario 1, you sell a naked IBM 165 put for $3.00. Unfortunately the debt bubble in Europe explodes and our markets drop too. At expiration, IBM is 120. You’ve lost $4500 minus the $300.00 you were paid for the put, so you’ve lost $4200.

      In scenario 2, you buy 100 shares of IBM at 165 and sell a 165 call at $3.00. Again, at expiration IBM is at 120. As in scenario 1 you’ve lost $4500 on the IBM shares minus the $300 you were paid for the put, which is to say that again you’ve lost $4200.

      If you’re comforted by the thought that you “still own a good stock,” that’s great! But you’ve still lost $4200 because as long as the money isn’t there for you to get, you’ve lost it.

      • Larry says:

        I understand your point, Dean, thanks.

        I see a big difference between the two scenarios. In Scenario 1 with the naked put you have lost REAL out-of-your-pocket money. In Scenario 2 with the covered call, you have a PAPER loss PLUS you still have an asset that at least has a chance recover its value in time. If it is a “good” stock, the chance of recovery is more likely than not, at least in the long run.

        • Dean says:

          Larry, I’m a second generation trader, and my dad drilled into me from an early age that there’s no such thing as a paper loss, that if the money isn’t there to get, you’ve lost it. That doesn’t mean you won’t make it back but until you do, it’s lost.

          To illustrate he gave me the following example, which I’ll adapt to my scenario. You have $10,000. You do the covered call as in scenario 2 and IBM goes down 45. You have a $4200 “paper loss.”

          Suddenly you learn that you desperately need an operation, and without it you will not survive week. The operation costs $9,000. A week ago, before IBM plummeted, you could have paid for the operation. Today if you liquidate you will have only $5800.

          So? Do you live or do you die? See why the “paper loss” is an illusion?

          Here’s another way to look at it. Let’s say you do scenario 1 and have a “real loss.” But you think IBM is a great value at 120, so you buy 100 shares. You’ve now transformed scenario 1 into scenario 2. Does that mean you’ve eliminated the “real loss” and transformed it into a “paper loss?”

          • Larry says:

            Dean,

            Sounds like your Dad was a wise man!

            At the heart of his example is whether or not one needs an operation or needs the funds immediately. If not, with a good stock, time is on your side to recoup the paper loss, unlike in Scenario 1 with the naked put where the money is out the door whether or not you have an immediate need for it.

            I guess there are two schools of thought on this. You were good to reply to my comments and I appreciate that you did. I learned something, which is always a good thing!

  5. Venkat says:

    Saying most options expire worthless is too generic statement. Did anyone in this forum conduct any research?

    How about the following options? Can someone prove that most of the following options expire worthless?

    1. Deep in the money options; DITM Calls in a strong bull market and DITM Puts in a strong bear market.

    2. Low IV options. Call options with low IV in a medium to strong bull market and low IV puts in a medium to strong bear market

    3. 1 to 2 years LEAPS that are closed 6 months early in advance.

    Sure, if you buy High IV options and Deep OTM options, you will lose money most of the time.

  6. Bruno Lefty says:

    also, the study does not say what options, it takes ALL options into consideration, even the ones written far far out of the money. Anyone could gget an 80% result with that sample size.

  7. Bruno Lefty says:

    This is a pretty STUPID study.

    Of course 80% of ALL options will expire worthless. 80% of options are written so far out of the money that they are doomed to expire worthless.

    However, this is nof no use to option sellers because these far out of the money options are usually so cheap that they are not enough to cover any potential losses.

    If i were to write a call for 100 when the price is 10, i too could make that option expire worthless 99% of the time even. But is it worth it if i’m only making a few cents from it?

    The truth is that 50% of SIGNIFICANT options expire in the money vis a vis the efficient market hypothesis. The ones that expire worthless are those that are not WORTH SELLING IN THE FIRST PLACE.

    This prevailing myth proves the stupidity of the average investor.

  8. Hollis Henle says:

    Youre so cool! I dont suppose Ive learn something like this before. So good to find somebody with some authentic thoughts on this subject. realy thanks for beginning this up. this web site is one thing that is needed on the web, someone with a little bit originality. helpful job for bringing something new to the internet!

  9. Paul says:

    Options expiring “worthless” is a mis-understood concept. IF I buy a call option for $500 hoping to see an increase in Stock ABC and the stock soars, why would I exercise the option when I could just as easily sell the face value of the option itself to someone else ? (which would now be worth $500 + most of the market gains). If that person, in turn, makes money he could do the same thing. There is often little incentive to actually exericise the option leaving the original sellers to clean up. However, occassionally, someone will make a wopping profit and want to exercise the option in which case the seller is in trouble.

  10. Chris says:

    Hi Dean,
    I enjoy your posts. I have talked with the folks at the CBOE, who confirm through some of their data that 80% of options that make it to expiration do expire worthless. The point I always make is that most traders don’t let their options get to expiration.
    Thanks,
    Chris

    • Dean says:

      True enough Chris. Personally, I like to be out by the time about 8 days remain until expiration. If you try to manage your position delta and gamma neutral, it becomes almost impossible within the last few days of expiration.

  11. [...] also confirmed the same thinking I have basically the same answer, save for a couple of further [...]

  12. kapil says:

    Hi Dean,

    Have you found gamma scalping to be a profitable strategy for you?

    Kapil

    • Dean says:

      Yes, but I use it fairly sparingly. It only works when the time is right.

      I wrote that article in May of 2007, when bullish optimism was at an all-time high. Maria Bartiromo of CNBC talked endlessly of the “Goldilocks Economy” – not too hot and not too cold – and wondered breathlessly what could possibly ever go wrong in such a perfect environment. Implied volatility on T-bond options was lower than I had seen it in the 23 years I’d been trading it, so I loaded up on premium (bought lots of options). Bonds dropped sharply soon thereafter, those two Bear Stearns funds went under, and it was a lovely time to be long premium and scalping gammas.

      When you see that sort of environment – excessive complacency – that’s the time to buy premium and scalp gammas.

      Also, any time you’re long premium and the underlying moves and you make money, you can always lock in your profits by getting delta neutral by buying or selling the underlying.

      • vJD says:

        Hi Dean,

        Understandable – but on the other hand gamma scalping should *not* work most of the time because realized volatility is empirically about 2-4% below implied vola – even in phases when imp. vola is only about 10%.

        How is you practical experience concerning this point – and how do you filter out the profitable situation?

        • Dean says:

          Well, like I said above – I do it only in times of exceptional complacency and historically low implied volatility. Such as T-bond options in May of 2007, as in my example. That’s the time to get long premium, because panic follows complacency like night follows day. There might not be a payoff immediately, but scalping gammas can help counter time decay while waiting for the mierda to hit the fan.

  13. JakeGint says:

    Also — would like to hear your opinion on the much mooted rumour that the silver markets are hopelessly gamed… your thoughts?

    • Dean says:

      The good people at Elliott Wave Institute have often said that silver tends to have one of the clearest EW patterns of any market. And in fact, they have been amazingly accurate in calling major turns in the silver market.

      If Elliott Waves are an expression of mass psychology, and silver follows classic EW patterns, I would say that argues against the notion that the silver markets are gamed.

  14. JakeGint says:

    Hi Dean.

    Look forward to your commentary on options. Feel free to do an advertorial posting on our site’s Peanut Gallery — http://www.ibankcoin.com