Does Selling Option Premium Give You an Edge?

A common misunderstanding among new option traders is that 90% of all options expire as worthless, so a seller of option premiums will have a higher win rate than a trader that buys options. This belief doesn’t take into account a statistic published by the Chicago Board Options Exchange (CBOE) that only 10% of option contracts are actually held until expiration and then exercised. 90% are bought back and closed before expiration so they are removed from the ‘expired for a loss’ statistic. They could have been closed for a loss or a gain BEFORE expiration.

Just because 10% of option contracts are held and exercised doesn’t automatically mean the other 90% expire worthless. This doesn’t take into account how options are traded profitably between when they are opened and closed. According to the CBOE, between 55% and 60% of options contracts are simply closed out prior to expiration. In other words, a seller who sold-to-open a contract will, on average, buy-to-close it 55-60% of the time, which could be at a profit before expiration. Very few option premium sellers are holding the short contract through to expiration, rather they are closing their position when the risk/reward ratio favors buying them back for a profit instead of holding the open risk until expiration.

If only 10% of open options contracts ever end up being exercised, and 55-60% get closed out before expiration, then only 30-35% of contracts expire worthless. This is AFTER they could have been traded back and forth for a profit for the entire time they were in the market. The real question that new option traders have to ask themselves is not how many options expire worthless, but of the 55-60% that actually get closed out before expiration, how many times did the option seller profit and how often did they buy back their short option to close for a loss? I would think that the majority of losing short side option trades would be closed before expiration for a loss to stop the risk exposure of a short contract that is going in-the-money. Option sellers could be closing their short option trades before expiration to cut their losses short. The question about what side of an option trade is the most profitable the short or the long side can’t be answered by how they expired in or out-the-money but how options traded over the full life of the contract. Options can fluctuate wildly in price over their life span and the open interest always fluctuates. Long side traders could be selling options for wins long before expiration. I know of almost no long side option trader that holds options until expiration. Options are so volatile that option traders must take their profits off the table while they are there not leave their profits exposed to loss until expiration.

Options are a zero sum game; for every long there is a short. For every option profit there is an option loss. Options are fungible and interchangeable so they are traded back and forth as they march toward expiration. Options will change hands many times before expiration and these trades are where option buyers can profit before their time runs outs. Options can be traded profitably from the long side by taking the profits while they are there. Option profits are not just determined at expiration, but are determined as they occur everyday. Option premium sellers can be hurt during trends. The risk and probabilities play out about even over the long run with option sellers collecting a lot of small wins and some big losses and the option buyers having a lot of small losses and some big wins. The winners are not on the long or short side exclusively but with the option traders with an edge, risk management, and discipline.  Consider this the next time the expiration statistic is tossed around in favor of selling option premium.