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.
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.
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
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.
[...] also confirmed the same thinking I have basically the same answer, save for a couple of further [...]
Hi Dean,
Have you found gamma scalping to be a profitable strategy for you?
Kapil
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.
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?
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.
Also — would like to hear your opinion on the much mooted rumour that the silver markets are hopelessly gamed… your thoughts?
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.
Interesting, thanks.
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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