Why Selling Options Is The Key To Success!
If there is one way that the most people lose money, it lies in buying options, whether they are call or put options. We have reproduced in part an article published in Futures magazine, March 2003, Option Sellers vs. buyers: Who wins? By John F. Summa. The article reads as follows:
Option traders rarely take into account a little known underlying fact about these derivative markets: Most options expire “Out-Of-The-Money”
.A study using lead gen and analyzing three years of data compiled by the Chicago Mercantile Exchange (CME) confirms it.
That means buyers lose on most option trades. Serious option traders need to think of formulating a net option writing method to get the best from the market.
One can see that three patterns emerge from the CME data;
- Nearly 3 out of 4 options held till expiration becoming worthless.
- The share of puts and calls that expired worthless was influenced by the primary trend of the underlying market.
- Option buyers still come out ahead even when the seller is going against the trend.
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 until expiry in five markets resulted in them being “Out-Of-The-Money and worthless”. The number remained consistent for the three year period.
Over 20 million options expired worthless. Over 6 million options that were exercised resulted in them being “In-The Money”. The options that are “In-The-Money” at expiration will be exercised automatically. We can also see different patterns from the data, such as: a trend bias affecting the percentage of call options and put options that end up becoming worthless. Clearly, however, the overall pattern was that most options expired worthless.
As a whole, S&P 500 recorded the highest percentage with 82.6% of put options expiring “Out-Of-The-Money or worthless”. This percentage was above the average for the whole study-76.5% of all CME Futures options expired worthless- and due to the stock index options on futures (NASDAQ 100 and S&P 500) having very large number of put options expiring worthless-more than 90%.
During the period, there were a few short-lived declines in the market. However, because of bullish bias of stock indexes favored put seller during the period. Data for 2001-03, however, would no doubt show a shift toward more calls expiring worthless, reflecting the change in a primary bear market trend since 2000.
Here are some of the main reasons in favor of options selling vs. buying:
- Going against the trend:
As is obvious from the above article even if you end up going against the trend, the odds are in your favor for Out-Of-The-Money options expiring worthless, while it is absolutely the opposite for the option buyers.
- Not controlled by greed:
When you buy options, you may be controlled by the greed as it may be difficult to determine when the trend may reverse itself. You may end up selling the option too late. This may not be the case when you are selling put options as in the worst case scenario you may end up owning the stock at a lower price than you may have intended to buy it at in the first place.
- No Stop Losses:
When you buy options, you may put stop losses below or above a certain price. You may do it based on a technical or a fundamental analysis. How many times does it happen that the market will go down or go up to your stop loss point, take you out of the market and then will reverse direction?
You may not have to place a stop loss order when you sell puts as in the worst case you will end up owning the stock at a price that you intended to buy at.
2. Time in your favor:
This is one of biggest advantages of selling options instead of buying them. Every option has two values. One is intrinsic value and the other is the time value. Even if the stock does not move against the trend, time value of the options will keep on eroding every day. Thus the option is of lesser value every day while the opposite is true when you sell options. The seller gains every day, even if the stock does not move at all.
3. Earn interest on other’s money;
When you sell options, it adds money to your account. Even though you may not be able to withdraw it, you earn interest on the money every day until the day of expiration. The opposite is true when you buy options. In this regard, you have to be very careful in selecting the right brokerage company. The majority of brokerage companies don’t pay interest on the money which is accumulated by selling options.
- Unlimited Risk:
When you buy the options, the maximum risk of losing your money is limited to the amount of money that you paid to buy those options. You will find the opposite is true for those who sell options. The seller risks having to buying back the option at a much higher price. However, there are ways to control this unlimited part of the risk by using several options strategies .
2. Limited Profit:
The seller of an option definitely has this disadvantage. The seller cannot possibly make more than the amount that he/she sold the option for.
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About the author:
Dr. Harsimran Singh was awarded a Ph.D. by a California University for his research work in options trading strategies and he authored 12 books. He traded stock options for 35 years. At times, he traded over a $100 million in a month in his personal account. His research work in options trading has been filed for patent with The US Patent Office under Application # 61/999,957.