Busting Myths about Options Trading: Not All Expires Worthless Means Poor Trading
Some mistakenly believe that since 75% of options contracts expire worthless, most options traders are not skilled. However, this is a misconception.
Primary Use of Options: Hedging, Not Income Boosting
Primarily, options are used for hedging against unfavorable market conditions rather than boosting income. While this may appear as zero-sum game on a micro level, the economic value provided by options cannot be denied.
Understanding the Statistics: CBOE Insights
The Chicago Board Options Exchange (CBOE) reports that only about 25% of options contracts expire worthless, while approximately 7% are exercised and 68% are closed out. This means that not all worthless options are indicative of poor trading. In fact, there is a high probability that some traders profit when options expire as worthless because the writer makes money from those same expirations. This tradeoff is part of the nature of options trading.
Optionality and Economic Purpose
Every option contract involves two parties: the buyer and the writer. One party always gains the equivalent amount that the other loses. Thinking of options in terms of lottery tickets is a helpful analogy: the option writer is the seller, who makes consistent money, while the option buyer has the chance to hit big, but not often enough to balance out the seller's losses. As an experienced trader, I sell a large number of options and buy fewer, always making money from this trade.
Strategy and Purpose Behind Option Purchases
While many options contracts expire worthless, it doesn't necessarily mean that the traders are unskilled. Many of these options are part of larger strategies that successfully hedge positions or generate income.
Some traders buy options as insurance. For instance, I might purchase a PUT option to protect a portfolio, hoping to lose the premium paid. This is akin to buying life insurance where the vast majority of customers never make a claim, but everyone still pays premiums to cover the potential losses that the insurer expects to incur.
In conclusion, the notion that 75% of options expire worthless means that most traders don't know what they are doing is incorrect. The existential fact that some options expire worthless simply means that not all hedging strategies work in all market scenarios. Consequently, successful options traders understand the nuances and use them as part of a broader strategy.