Selling Options: The Real Story

There are old sayings in the futures industry that go something like this: “Eighty percent of all options on futures expire worthless.” And, “The only way to make money trading options on futures is to sell them–not buy them.” Neither one of these statements is accurate. This educational feature will focus on the advantages and disadvantages of selling (also called “writing”) options on futures.

But before I discuss writing options on futures, let me first elaborate on the first “old saying” that 80% of options on futures expire worthless. While I have heard the saying many times through the years, I have never seen credible statistics on the percentage of futures options “that expire worthless.” Maybe it’s because such a statistic cannot be compiled. Consider this: If a trader hedges his straight futures positions with options purchases, and those options do perform their function of limiting risk for a period of time, then those options have performed their intended function–even though they may expire “worthless.” Also, most speculative options buyers who make profits on trades do sell their options before they ever expire. Thus, I expect it would be very difficult, if not impossible, to have any accurate statistics on the number of futures options that are bought and sold that did not successfully fulfill their intended purpose.

A major appealing factor for speculative traders to sell (or write) options, as opposed to purchasing options, is that the odds are more favorable for producing a winning trade. Reason: If a trader is writing options, generally the market can move “against” the trader by a certain amount before the trader sees his option’s strike price hit and he starts to lose money. Also, the option writer has “time decay” working in his favor—meaning that the day the option is sold, its time premium starts to decay as the option moves toward expiration.

Now you might be thinking this options-writing stuff all sounds pretty easy, huh? Well, hold on just a minute! Remember that there are trade-offs in every aspect of trading futures. Here’s the “rub” with selling options:

–First, the premium traders collect for writing options is generally not nearly as much as the profits a trader would collect on a straight futures trade or a winning options purchase trade. For example, if a trader sells a call option on corn futures for 10 cents, that is his profit. But then he has to wait (or “squirm” might be a better way to put it) until the option expires to secure his
profit. For many traders, pocketing just 10 cents profit on one corn contract is not much, so they may sell several contracts to make a bigger overall profit. Read on…

–Second, when writing options (just like in straight futures trading) you cannot absolutely limit your risk of loss. Margin money is required by the broker.

— Finally, there is one more “old saying” regarding writing options on futures. It goes something like this: “A trader will make money and make money and make money writing options…until that one time when an option sale will go against the seller. And that one options sale will then take back all the profits that were made on the previous winning options sales—and then some.”

I do want to be clear on one point. There are very good and successful traders who do employ options-writing strategies. I have another “old saying” that I use frequently when discussing a trader’s methodology. “If it ain’t broke, don’t fix it.” If there are options writers reading this educational feature and you are having and have had consistent success—more power to you!

The main point I want to make in this feature is that there is generally more risk and generally less reward involved in writing options than in purchasing options on futures. The one big advantage of buying options on futures is that the price you pay for the option is the most you will ever lose on that trade. Also, there is no margin required. That’s very good money management.

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