Trading Options: Data Shows That 75% or More of Options Expire Worthless

(Trading Options) Do Option Sellers Have a Trading Edge?

by John Summa,CTA, PhD

While there are certainly many viable options-buying strategies available to option traders, options expiration data I obtained from the CME covering a three-year period suggests that buyers are fighting against the odds. Based on data obtained from the CME, I analyzed five major CME option markets – the S&P 500, eurodollars, Japanese yen, live cattle and Nasdaq 100 – and discovered that three out of every four options expired worthless. In fact, of put options alone, 82.6% expired worthless for these five markets.

Understanding options trading

This study analyzes data compiled by the Chicago Mercantile Exchange (CME) for a special options report prepared for this my book, Options on Futures: New Trading Strategies (Wiley & Sons), co-authored by Jonathan Lubow, vice-president of Trader’s Edge, Inc., a futures and options brokerage based in Madison, NJ.
Three key patterns emerge from this study: (1) on average, three out of every four options held to expiration end up worthless; (2) the share of puts and calls that expired worthless is influenced by the primary trend of the underlying; and (3) option sellers still come out ahead even when the seller is going against the trend.

CME Data
Based on a CME study of expiring and exercised options covering a period of three years (1997, 1998 and 1999), an average of 76.5% of all options held to expiration at the Chicago Mercantile Exchange expired worthless (out of the money). This average remained consistent for the three-year period: 76.3%, 75.8% and 77.5% respectively, as shown in figure 1. From this general level, therefore, we can conclude that for every option exercised in the money at expiration, there were three options contracts that expired out of the money and thus worthless, meaning option sellers had better odds than option buyers for positions held until expiration. 

 


Figure 1 – Source: CME Exercised/Expired Recap For Expired Contract Report

We present the data as trading options exercised versus those expiring worthless. Figure 2 contains the actual numbers, showing that there were 20,003,138 expired (worthless) options and 6,131,438 exercised (in the money) trading options. Futures options that are in the money at expiration are automatically exercised. Therefore, we can derive the total of expired worthless options by subtracting those exercised from total options held to expiration. When we take a closer look at the data, we will be able to spot certain patterns, such as how a trend bias in the underlying affects the share of call options versus put options expiring worthless. Clearly, however, the overall pattern is that most options expired worthless.

Figure 2 – Source: CME Exercised/Expired Recap For Expired Contract Report

The three-year averages of exercised options (in the money) versus options expiring worthless (out of the money) for the markets examined below confirm what the overall findings indicate: a bias in favor of option sellers. In figure 3, the totals for exercised (in the money) and worthless-expired options for the S&P 500, NASDAQ 100, eurodollar, Japanese yen and live cattle are presented. For both puts and calls traded in each of these markets, options expiring worthless outnumbered those expiring in the money.
For example, if we take S&P 500 stock index futures options, a total of 2,739,573 put options expired worthless compared with just 177,741 that expired in the money.
 

 

 

Figure 3 – Source: CME Exercised/Expired Recap For Expired Contract Report

As for call options, a primary bull market trend helped buyers, who saw 843,414 call options expire worthless compared with 587,729 expiring in the money -clearly a much better performance by option buyers than put buyers. Eurodollars, meanwhile, had 4,178,247 put options expiring worthless, while 1,041,841 expired in the money. Eurodollar call buyers, however, did not do much better. A total of 4,301,125 call options expired worthless while just 1,378,928 ended up in the money, despite a favorable (i.e. bullish) trend. As the rest of the data in this study shows, even when trading with the primary trend, most buyers still ended up losing on positions held until expiration.

Figure 4 – Source: CME Exercised/Expired Recap For Expired Contract Report
Figure 4 presents the data in terms of percentages, which makes it a little easier to make comparisons. For the group as a whole, put options expiring worthless for the entire group had the highest percentage, with 82.6% expiring out of the money. The percentage of call options expiring worthless, meanwhile, came to 74.9%. The put options percentage expiring worthless came in above the average of the entire study cited earlier (of all the CME futures options, 76.5% expired worthless) because the stock index options on futures (Nasdaq 100 and S&P 500) had very large numbers of put options expiring worthless, 95.2 % and 93.9% respectively.
This bias in favor of put sellers can be attributed to the strong bullish bias of the stock indexes during this period, despite some sharp but short-lived market declines. Data for 2001-2003, however, may show a shift toward more calls expiring worthless, reflecting the change to a primary bear market trend since early 2000.
Conclusion
Data presented in this study comes from a three-year report conducted by the CME of all options on futures traded on the exchange. While not the entire story, the data suggests overall that option sellers have an advantage in the form of a bias towards options expiring out of the money (worthless). We show that if the option seller is trading with the trend of the underlying, this advantage increases substantially. Yet if the seller is wrong about the trend, this does not dramatically change the probability of success. On the whole, the buyer, therefore, appears to face a decided disadvantage relative to the seller.
Even though we suggest that the data understates the case for selling because it does not tell us how many of the options that expired in the money were winning rather than losing trades, the data should say enough to encourage you to think of developing selling strategies as your primary approach to trading options. Having said that, however, we should emphasize that selling strategies can involve substantial risk (buyers, by definition, face limited losses), so it is important to practice strict money management and to trade only with risk capital when deploying selling strategies.

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20 Comments

  1. Ron on October 12, 2009 at 8:10 am

    This advantage is good news for low risk traders.
    Wonder if the advantage was different to the option seller during the 2007 to 2008 bearish market when so many lost badly. Should we assume that option sellers did not lose as much.

    By what percentage does the sellers advantage gets better when your money management stragegy is practiced.

    Can you explain clearly what it means when you suggest “trade only with risk capital when deploying selling strategies”

  2. Genius on October 12, 2009 at 12:28 pm

    Actually, these figures are something I have heard about for a long time now well before 2007.

    I am not sure how much better the numbers get when you add in my money manasgement style, I have never compared it. The way I trade, I never get close to the money. So if a stock closes on expiration day at 50.25, all the puts at $50 and below will expire worthless. But if I was in that trade, I would have been out much sooner and never let my short strike get that close to the money.

    So while my win percentage is close to 75% of all trades I hardly ever have a trade that goes to expiration.

    Trading only with risk capital means you should only play with money you can afford to lose – just like in any investment.

  3. Tommy Borskey on December 17, 2009 at 4:59 pm

    wouldn’t it be that all the puts or positions $50 and above will expire worthless?

  4. Otto1939 on January 3, 2010 at 11:57 pm

    no… Genius is right.

    The put buyer will ‘put’ the shares to the put seller only if the contract price is higher than the market price (here $51 an up compared to $50.25). In other words when he gets more from the put seller than from the market.

    The put buyer will sell his shares at market price if the market price is higher than the contract price ($50 and below); i.e. the puts with a contract price lower than the market price expire worthless (here $50 and below).

  5. Rich Price on February 25, 2010 at 11:20 am

    The problem I have is when the trade gets close to the money, all it would take is one quick move to hit maximum loss. The recent SPX iron condor (Feb options) is a case in point. I believe it expired slightly in the money which was ok, but it could have easily been a disaster if the market moved suddenly. I just don’t know if this is worth the risk??

    • Genius on February 25, 2010 at 3:09 pm

      That’s why it is a good idea to adjust away from the money. (The SPX trade expired out of the money). You normally never want to get that close to the money.

  6. Joe Black on July 10, 2010 at 12:23 am

    My strategy is to sell Naked Puts slightly in the money
    when the underlying appears to be trending up. If the trend
    reverses and the stock is Put to me, I sell Covered Calls
    on this same stock, slightly in the money. What do you
    think of this approach? I try to choose expiration dates
    4 to 8 weeks out.

    • Genius on July 11, 2010 at 12:05 am

      Selling cash secured puts is a good strategy. The only problem is when something really bad happens to the stock and it drops well below your put. Then you are stuck with a large loss or a stock that might never go back up and the premium on a low priced stock will not be anything to write home about. It might take years to get back to even if the company doesn’t go out of business in the meantime.

  7. NYCBRI on September 2, 2010 at 3:34 pm

    @ Genius says:
    July 11, 2010 at 12:05 am

    You make a valid point of being stuck with a position that never recovers but if you sell puts simply as a means to enter a position you are interested in, than you would have encountered the market move even if you purchased the shares without the use of selling a put option.

    Example: I want to purchase ED and my price range is $47 to $49 and it’s trading $49. Therefore I sell a put for $47 and collect the premium. If it falls below and the shares are put to me than I ma in a similiar position if I simply purchased at $49

  8. Dave on September 14, 2010 at 4:38 am

    I think this study is a bit misleading in that it only deals with options that expire. What we don’t know (and I’m not sure how to measure it) is what proportion of option traders are in it purely for the options ie with no intention of going to expiration. A profitable option will be sold prior to expiration, and will not show up on the “plus” side of studies like this – thereby putting a serious skew on the results. How much of a distortion? Enough to invalidate the results? Who knows?
    As Genius said in his response to Ron – he never lets his trades get that close – he would out before any chance of expiration – meaning none of his trades would show up in this study.
    Statistics are great, but I have found that you generally have to be a lot more careful about what they do not show or include than what they do.

    • Genius on September 28, 2010 at 2:18 pm

      Profitable options will be exercised and will thus not expire.

      The only time an option will expire worthless is if the buyer of the option does not feel it is worth it to exercise (meaning the option is out of the money or very close to it) or if the trader screws up and does not choose to exercise (which does not happen much, especially at large firms).

  9. Anil on October 7, 2010 at 8:58 am

    I trade only in Index Option which is European Style . It cannot be assigned . It will be settled in cash , where as stock has the risk of assignment when you go out . As Genius said , sometimes you get struck in the stock for a very long time . Only God will know previous rate will come or not even after many years of holding. In Index options we will not get struck. It will move with the market. There is huge liquidity in Index options.
    Some bad news or good news on a particular stock will not effect the index. In Index option as the liquidity is high one can adjust in various methods but where as in stock it is less flexible than index.

  10. Anil on October 7, 2010 at 9:08 am

    Genius, I am able not able to understand how unlimited risk is in Iron Condor Strategy.

    Suppose I am Selling CE 6000 at 133
    ” PE 6200 at 170
    Buying CE 6300 at 125
    ” PE 5900 at 104

    Calculating this maximum profit will be 7400 and maximum loss will be 2600. If this calculation is correct, then where is the question of unlimited risk in Iron Condor.
    Please correct me if I am wrong.

    • Genius on October 8, 2010 at 9:41 am

      The risk is a iron condor is limited. You can lose only the margin amount.

  11. Anil on October 8, 2010 at 9:52 pm

    Ok. Thanks

  12. Joe Black on October 9, 2010 at 1:15 am

    In item #6 above you zeroed in on my sale of “in the money”
    Puts only. This is only half the strategy. If a stock is
    put to me I quickly sell an “in the money” Call. If the stock continues to fall, I follow the stock down and contin-
    ue to sell “in the money” Calls going out 4-8 weeks. I can
    do this 6 to 8 times in a year, bringing down my cost basis
    until the stock is assigned to the Call buyer. I look forward to your opinion of the complete strategy – Puts and
    Calls. Thanks for your help.

  13. keith on February 21, 2011 at 9:09 pm

    i’m all for this. not skeptical. just have question. aren’t most of or a lot of options on a particular chain well out of the money- or worth 3-4 cents and not even traded much. and these would be included in the 75% that expire worthless. so, are most of the 75% ones that no one would trade anyway so they wouldn’t really count . —as i write this i’m thinking there are as many way out of the money options as there are in the money options. the ones way in the money usually won’t expire. so why isn’t it around a 50% average instead of 75%?

    • Genius on February 22, 2011 at 1:30 pm

      It can get confusing.

      I beleive the author was also counting the far out of the money options that traded for .05 or less as well.
      Those might be not traded much but they can be traded otherwise they would not be listed. They might still have some volume.

      The final ratio is not 50/50 because there are not the same amount of options listed above and below the price of the stock. For example, I am looking at the MCD Option Chain right now on 02/22/2011. The stock price is 75.92. for March expiration in the puts there are 15 listed puts out of th emoney and 6 puts in the money. The opposite is true for the calls. So if we look at only the strikes, then yes it should be 50/50. But you have to look at the volume of options traded.

      That is where this study gets the 75% number. By adding up all the volume of traded options and looking at if they expired or were exercised you can tell what percentage of options expire worthless.

  14. Val on April 3, 2012 at 3:27 pm

    I think the reason statistically for most options expiring worthless is due to portfolio managers buying options as a downside protection, knowing ahead of time and in fact hoping for options to expire worthless.
    The reason for buying options to protect the stock position is US taxation system. Taxes are higher for profits from short term stock trades, so instead of liquidating a stock position when portfolio manager thinks is the top or bottom, he/she can buy a protective put/call instead to lock into gains.

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