“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)
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
September 16, 2015
New York Stock Exchange
4:20 PM – 5:15 PM
Recently quoted in an article written by the Chief Editor of the American Association of Individual Investors
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 %.
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,