Do 80% of Options Expire Worthless?

by Gavin in Blog

June 8, 2020 • 5 comments

There’s a saying in the options industry that 80% of all options expire worthless. If true, this would have huge implications for how traders manage their positions.

The reason this statistic exists is because of how certain assumptions are made based on misrepresented data.

In general, only 10% of option contracts are exercised. This is a true and measurable statistic.

What some commentators and brokers do, is flip the data. Since only 10% of options are exercised, they take it to mean that the remainder must have expired worthless. Throw in some conservative maths for anomalies and voila you get 80% of options expiring worthless.

To a new options trader, on the surface that might appear to be a logical and fair assessment. So when the brokers and other commentators provide retail traders with trading strategies it’s always the same – sell options and rely on income generating strategies. Everything else is just a gamble apparently.

If it was really the case that most options expire worthless, what would be the incentive for option buyers to take the risk? Wouldn’t they just sell options too, knowing they can have an 80% win rate?

But options trading is a zero sum game. It means that for every buyer there has to be a seller. If selling options truly had such a high win rate, everyone would take advantage of that fact.

So the question is then, why aren’t they? The answer lies in the data.

What Does The Data On Options Expirations Tell Us?

Rather than guessing what’s happening based on an assumption, we need to use hard data instead.

First, we know that 10% of options contracts are exercised. This means 90% of contracts aren’t exercised. This is very different to saying 90% expire worthless. The former is data, the latter is an assumption based on that data.

So the next thing we need to do is to ask the question why are 90% of contracts not exercised and do they expire worthless.

Thankfully, we have data on this. It turns out that approximately 2/3^rd (65%) of option contracts are closed out prior to expiration.

This means that during the course of a regular expiration cycle, the majority of contracts that have been created will be closed out.

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For example, if the price of an option became low enough, the seller of the option would buy it back, closing out their position and making a profit.

Likewise, if prices move up, a buyer of an option could sell at higher prices and lock in a profit.

So on both sides of the transaction (buyer and seller), there are conditions that will incentivize them to close out a position before contract expiry.

Since not all contracts are closed out prior to expiry, it means some will indeed expire worthless.

As 2/3^rd (65%) of option contracts are closed out prior to expiration, this means that actually only the remaining 1/3^rd (35%) of option contracts will reach expiration date. Some of those will expire worthless and some that are in-the-money will be exercised.

It’s easy to see that if you were to only include those contracts that are still open at the expiration date into your data set, you too would be seeing really high rates of options expiring worthless, misrepresenting what actually happens to options over the expiration cycle.

Why It’s Important To Know

Knowing the true statistics behind the number of options expiring worthless is incredibly important for retail traders. Without this knowledge, retail traders are at risk of being pushed into strategies that solely rely on one type of trading, backed by a faulty assumption. A sure recipe for losing money.

The Chicago Board Options Exchange (CBOE) has published data on option expiries, and one interesting conclusion they made is that even if an option expires worthless, it doesn’t actually imply that the trade was profitable. For example, the expired option may have been a part of:

• A multi-legged strategy. These may have one leg reap enough profits to cover the loss for a leg that expired worthless.
• As we’ve touched on previously, an option may have been profitable before expiration and so was closed out.
• If part of other strategies such as covered call writing, it may have been an overall net profitable trade.

Conclusion

Market commentators and brokers sometimes tout that 80% of options expire worthless. This is based on a faulty assumption and is not grounded in hard data. More specifically, it doesn’t consider the number of options closed out prior to expiration.

When using all the data properly, the true rates are:

• 10% of option contracts are exercised.
• 65% of option contracts are closed prior to expiration.
• 35% of option contracts expire worthless or are exercised.

Knowing the facts will help traders in avoiding educators with bogus claims and enable them to take advantage of opportunities involving buying options.

Trade Safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.