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Percentage Of Options Expiring Worthless: Debunking A Myth

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%.

 

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With thanks to Darius and my amazing team.

 

Next live appearances

1- St. Louis, Missouri

September 15, 2015

6:30 PM – 9 PM

Link to register

 

2- All Stars of Option Trading

September 16, 2015

Discussion panel

New York Stock Exchange

4:20 PM – 5:15 PM

ALL_STARS_OPTIONS

 

Recently quoted in an article written by the Chief Editor of the American Association of Individual Investors

 

http://www.aaii.com/files/investorupdate/20150820.html?a=update082015

 

 

 

Market tone

US and Global markets were negatively impacted by more bad news from China, Japan and Russia. Investors sold off stocks and moved into bonds and gold. This was exacerbated Friday by the weakest reading from China’s factory sector in six years. The CBOE Volatility Index hit 28, a high not seen in 2015, and the S&P 500 Index fell into negative territory for the year to date. In addition to this broad and steep sell-off in stocks were further drops in prices for commodities, including oil and copper. This week’s US reports:

  • New US home construction and resales both rose to eight-year highs in July
  • Residential construction starts increased 0.2% to an annual rate of 1.21 million units
  • Existing home sales also climbed 0.2% to an annual rate of 5.59 million, their fastest pace since 2007
  • Sales were 10.3% higher than a year ago
  • Building permits fell 16.3% to a 1.12-million-unit annual pace after three straight months of major increases
  • Homebuilder sentiment, a leading indicator, rose to its highest reading since November 2005
  • US manufacturing PMI fell from a final July reading of 53.8 to a preliminary figure of 52.9 in August, its weakest pace in almost two years. Economists had expected a slight increase to 54.0
  • The US Consumer Price Index moved 0.1% higher in July and 0.2% year over year
  • Core CPI, excluding food and energy costs, also rose 0.1% in July and 1.8% for the 12-month period
  • Minutes from the US Federal Reserve’s July policy meeting gave no clear indication that the Fed will raise short-term interest rates at its mid-September meeting. Though the firming labor market raises the likelihood of a rate hike, persistent low inflation and global economic deterioration could lead the Fed to delay the increase
  • Initial jobless claims rose 4,000 to 277,000 for the week ended 15 August
  • The four-week average has been below 300,000 for 21 straight weeks
  • Continuing claims dipped 24,000 to 2.25 million for the week ending August 8th

For the week, the S&P 500 declined by 5.77% for a year-to-date return of (-) 4.27 %.

Summary

IBD: Market in correction

GMI: Not available (on vacation)

BCI: With the extreme sell-off this week, the VIX has moved up to 28, the highest level since October, 2014. This creates two issues. First, option premiums will go higher and second is a psychological component. Panic -selling can cause a further decline until the market stabilizes. Some investors, on the other hand, may see this as a buying opportunity. I plan to wait a few days into next week before setting up my game plan for the September contracts. We have seen this before and the market usually recovers in the near term.

Wishing you a better week ahead,

Alan (alan@thebluecollarinvestor.com)

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

17 Responses to “Percentage Of Options Expiring Worthless: Debunking A Myth”

  1. Barry B August 22, 2015 3:41 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 08/21/15.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,

    Barry and The BCI Team

  2. Hanze August 23, 2015 11:05 am #

    Allan
    Selling and buying options on a long or stock positions
    Covered calls are much discussed and although
    I believe in this option tool and am trying to master it although
    No one ever does they just get good at it
    It’s the element of risk that can never be neutralized

    I have had equal sucres with covered puts
    With shorter time values and quicker closures

    Although not enough is discussed about it

    I have refined my trading
    To Weekly in the money call option selling on a select number of stocks and am managing with the additional sale of calls or puts
    In that weekly time period to make a profit
    I always position myself too be assigned at the close

    I give myself a deserved rest on the weekend
    And start fresh on Monday and decide on the weeks trade

    I set a goal of 1 percent return per week on invested capital

    Hanze

    • Alan Ellman August 24, 2015 7:08 am #

      Hanze,

      As you go through my material you will note that I consistently repeat that there are many ways to make money in the stock and option markets. Certainly using cash-secured puts (covered puts involve shorting a stock…don’t think you meant that?) with Weeklys is one of those ways. There are pros and cons with Weeklys and as long as we master those nuances I have no issue with the strategy you present and thank you for sharing this approach with our BCI community.

      Alan

      • hanze August 25, 2015 11:19 am #

        Thanks for your reply
        I got your Book I ordered today “Complete Encyclopedia for Covered Call Writing”

        Great Book full of insight and easy reading
        Should be a must reading for any serious trader or investor

        I consider myself a TRADER
        so I am biased towards useful info I get from your penmanship

        My Weekly deep in the money call writer on select stocks
        continues to work and gives me my 1% weekly return on capital

        Every Friday expiration date is a challenge, but its what makes a
        good options trader
        I always position myself for assignment
        It is still amazing the amount of time value that remains
        on the last trading day

        Getting Called away is why I sell options
        and the natural outcome of this kind of trading
        Getting exercised is great
        Bring it on
        So I can get some more Exercise on the Weekend

        Hanze

        • Hanze September 2, 2015 8:35 pm #

          Yes Allan
          I am in the 10%
          Who have their sold options execercised

          Just 10% of trader who are happy to be exercised

          I am in good company

          It is a. Choice
          And I make 1% per week Capitol return

          On selling weekly in the money call options
          Which expire every Friday

          And I don’t make a trade until Wednesday at the latest

          Love repositioning
          On expiration Friday for. Max Profits
          Which always includes addition sale of naked puts or calls
          Expiration day is nothing to fear

          Hanze

  3. Karen August 23, 2015 11:16 am #

    Alan,

    What percentage of your stock positions are sold before expiration? I have some dividend stocks that I would prefer not to sell.

    Thanks,
    Karen

    • Alan Ellman August 24, 2015 7:11 am #

      Karen,

      I never calculated this percentage but it is quite small, probably under 3%. It would be even less if I wanted to avoid early assignment because of ex-dividend dates by selling the option after the ex-date or selling a 2-month option with an expiration the month after the ex-date.

      Alan

  4. Keith August 24, 2015 1:55 am #

    My year to date ROI dropped from 10% to 3.8% due to the recent market crisis.

    Keith

    • Alan Ellman August 24, 2015 7:21 am #

      Keith,

      The market is down 5% in that same time frame. You are doing quite well under these unusual circumstances.The glass is half full.

      Alan

  5. Daniel August 24, 2015 2:11 am #

    Alan,

    How are you weathering this market so far? Are any of your puts deep-in-the-money? How do you manage that when it happens?

    • Alan Ellman August 24, 2015 7:28 am #

      Daniel,

      In my put book and DVD program I describe a 3% guideline where a short put is closed when the stock price moves more than 3% below the strike price. Barring an extreme gap-down, this will usually keep us out of trouble.

      Alan

  6. Jay August 24, 2015 6:21 pm #

    Friends,

    As John Lennon sang: “Strange days indeed. Most peculiar, Momma.”

    One asset class – at least I think of it as one – not to be overlooked is volatility. The VIX and it’s derivatives are a complicated bunch. You should understand how they work and the difference between backwardation and contango before you dabble. Please re-read that sentence several times :).

    But many in this community have been around the block. So my suggestion is SVXY. I started a position Friday and added today. I plan to add a little every day we get sell offs while the VIX is 30+. This is one you layer into while the market implodes then wait for the VIX to mean revert back to below 20 which it always does.

    It could be used with any of Alan’s strategies. Just don’t be lured in by it’s premiums. They are high because SVXY is a live snake and if you are not an experienced snake handler please avoid it!

    Just an idea for a long at a time when fear is high. A look at it’s chart will suggest it has been a great buy at market low points.

    Even if you do not catch the bottom, as few do, adding SVXY on dips can be a more positive way to view this correction than panic selling your stocks. Betting on VIX to come down from spikes – even if it takes a while – has been a consistent winner. And SVXY does not expire. – Jay

  7. Alan Ellman August 25, 2015 5:34 am #

    Market positioning:

    Pre-market futures on Tuesday are showing the potential for a rebound day. This would be a welcome relief from the recent selloff but the question becomes, is it sustainable? The talking heads will disagree because no one knows for sure. The CEO of Apple Computer Tim Cook came out with a rare mid-earnings report comment stating that the company is performing quite well in China for July and August as China remains the prime culprit for recent declines.

    In my view, we are in a phase of panic-selling and this may lead to the Fed to putting off an interest rate hike until December or even next year. Volatility is high and the normal rules that define the market are not in play until have more stabilization than a possible 1-day rebound. I am currently holding on to the stocks in my portfolio but not taking on any new covered call positions until we have more color and definition as to market direction.

    This is not 2008 as our economy is still doing well. I view it more of a short-term aberration. After the debacle of 2008, many retail investors sold low and never re-entered the market due to fear of a recurrence of another out-of-control selloff. Since then the market has tripled. We must all stay within the framework of our personal risk-tolerance. However, the lesson from 2008 is that short-term pain does not justify long-term panic.

    Alan

    • Walter August 25, 2015 6:25 am #

      Alan,

      Jim Cramer had similar sentiments yesterday when he said that it is a stock market gone wild but not an economy gone wild.

      Walter

  8. Alan Ellman August 26, 2015 6:01 pm #

    Premium members,

    The latest ETF Report has been published on your member site. Aside from the 4 Inverse ETFs, only 4 other eligible ETFs are in positive territory over the past 3 months. Even with today’s impressive rally, I am unsure if the market over-reaction (my opinion) to events in China is in our rear-view mirror. At this time, I am keeping all securities currently in my portfolio but not adding any new ones or writing any calls on them. Once a bottom is established and the bull market continues as we re-focus on our still-healthy economy (my opinion also) it will be business as usual in my stock and option portfolios.

    I am pleased to announce that we are accepting pre-ordering for Volume 2 of the “Complete Encyclopedia for Covered Call Writing” I have approved final editing and the book is being printed as I type. Below are the early-order discount promo codes to be used for $10 (through September 4th) and $5 (September 5th through the 11th) discounts. Only soft-cover versions are available at this time. Hard-cover and kindle versions will be available in the fall. Shipping will begin the second week of September based on when the order was placed. Here is the link to the information page:

    http://www.thebluecollarinvestor.com/alan-ellmans-complete-encyclopedia-for-covered-call-writing-volume-2/

    Promo codes:

    volumetwo10: $10 discount now through September 4th

    volumetwo5: $5 discount from Sept. 5th through Sept. 11th

    ***Shipping to begin the 2nd week in September

    (This weekend’s stock report will be published on Sunday evening as some team members are on vacation for a final summer fling.)

    Wishing all our members much success,
    Alan

  9. William August 27, 2015 2:55 pm #

    Could you please clarify this for me? I can’t get a satisfactory explanation. SLB is buying CAM
    for about $62/share. The deal will be completed first quarter of 2016. This morning, I was able to write a put at a strike price of $55 with an expiration date of Jan. 2017 and receive $4/share. Does this make sense?

    • Alan Ellman August 27, 2015 5:35 pm #

      William,

      The share price was re-set yesterday at the proposed purchase price of $62.00. By selling a $55.00 January, 2017 put you are taking on 17 months of obligation for an unexercised return of 7.8% which annualizes to 5.5%

      Deep out-of-the-money calls or puts will have a small time value component in this case a little less than 1/2 of 1% per month.

      Alan

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