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What about
options that are closed before expiry? One could hazard a guess that most options closed near expiry would be either in-the-money, at-the-money or just out-of-the-money.
Why? In-the-money options will behave more and more like underlying deeper they are in-the-money and closer they get to expiration. Holding in-the-money options therefore will carry more risk. This could be a reason why some holders may want to close their in-the-money positions prior to expiration. Out-of-the-money options on other hand may be worth very little and hold little risk (low delta/gamma/theta/vega). Therefore you might say there is larger chance of an out-of-the-money option being held until expiration.
Therefore, 50%-60% of options that CBOE claim are closed before expiration could also be weighted towards in-the-money options. For numbers below, we will assume split is 60-40% (60% in-the-money and 40% out-of-the-money).
So then, majority of 30-40% that go on to expiry would therefore be out-of-the-money and of course would expire worthless like out-of-the-money options do. Does that mean you should be a net seller? Does that mean 70% of options “expire profitable to seller”?
Let’s play with some numbers. Let’s say we have an exchange with 1,000 open option contracts.
•First, 10% of options (all in-the-money) are exercised early leaving 400 in-the-money and 500 out-of-the-money. There are 900 options remaining. •Then 55%* or 550 of initial pool are closed out leaving 350 open contracts. (* 55% is half way between 50-60% CBOE number.) •Of these 550, we need to estimate how many are in-the-money and how many are out-of-the-money. Since we have established a weighing towards in-the-money options, let’s assume 60% of these are in-the-money and 40% are out-of-the-money. •In end, we have 350 contracts run to expiration.
Based on our calculations, that would leave 70 in-the-money options and 280 out-of-the-money options that will run until expiration. (see table). Based on one assumption above, 80% of options that will go to expiry are out-of-the-money and therefore will expire worthless.
TOTALIn-the-moneyOut-of-the-money 1000500or 50%500or 50% Early exercise (10%)1000 Remaining900400500 Closed positions (55% of 1000)550330220 Option to trade to expiry35070 or 20%280or 80%
So now figures make sense. Perhaps 80% of options that run to expiry do expire worthless. (Perhaps real figure is 70% or 90%.) However that is not same as saying 80% of ALL options expire worthless. Can you see difference? Furthermore, coming to conclusion that is it better to be a seller than a buyer from a single biased statistic like this is plain nonsense.
In a topic like that of as options trading, it is easy to get caught up with statistics, but if we take time to think and research before drawing conclusions, then surely we will become better traders.
The author, Guy Bower, is director of Options1 Trading Advisory. Options1 is an independent and licensed commodities trading advisory with clients around the world. Guy has authored two best selling books on Options and Hedging.
For a free report titled, “Don’t Let FEAR get in your way from making profits in Options trading”, please visit www.optionsguy.com
