This is a recurring argument and one that has become a pet peeve of mine. In fact, it just surfaced once again on our discussion board so I thought I would add a post to our blog and in the future I can just refer folks here to save the wear-and-tear on my computer's keyboard.
The argument typically goes that it is better to sell options rather than buy options. The reasons offered to support this statement often include a reference to the "fact" that 90% of options expire worthless. This, of course, is rubbish. In fact, the Chicago Board Options Exchange ranks it as the #1 options myth in their Options Adviser's Knowledge Center, here.
So, I guess it's not just me. Nonetheless, it seems to be a rather popular piece of misinformation. But, where does it come from?
The truth is that a majority - we're talking 50% or more - of options are closed before expiration. Option buyers sell their options and option sellers buy-to-close their short positions before they expire. What's also true is that about 10% of options end in assignment. According to the CBOE, only about 30% to 35% of all options reach expiration and actually expire worthless, though.
So, where does this myth that 90% of all options expire worthless come from and why does it keep cropping up? The best explanation I can offer is that it comes from flawed reverse logic; i.e., if 10% of options are assigned then that must mean that 90% of options expire worthless.
But, if we can so easily disprove this statement why does it continue to be repeated?
The cynic in me says that it is perpetuated by those who want to sell their version of an option selling strategy. They tell their prospective clients "the odds are dramatically in your favor because...(wait for it)....90% of options expire worthless". While I have little doubt there is some of that out there, I also think that this statement gets passed around by those retail traders who are working hard trying to understand options and formulate a reliable method of generating profits routinely.
Selling out-of-the-money options does offer a nice probability of success and statements like that pet peeve of mine only reassure new traders that they are right to be an option seller. The odds are in our favor! Right? Well, yes. But, there is a ying to that yang and a zig to that zag.
Options represent balance between risk and potential reward. The more we push the probabilities to our favor by, well say, selling out-of-the-money options, the more we increase our potential risk and reduce the possible reward. So, there is no inherent edge to be gained simply by the act of selling options versus buying them. You can make and lose money equally well doing either.
As you evaluate option strategies keep in the back of your mind that you need to give something up in order to get what you're after. If you want a high probability of success, you're going to have to shift that risk-reward equation against yourself.
Sorry if I burst a bubble...
Should you trade high probability positions like out-of-the-money short options? The answer to that question depends upon you and your situation, but in general the answer is that selling out-of-the-money option premium can be an effective trading technique. The caveat is that you need to recognize and manage the risk associated with this approach.
Christopher Smith
TheOptionClub.com
P.S. Learn more about trading high probabilty options strategies while effectively managing risk when you join us as a Free Member here at TheOptionClub.com.
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