I’ll add that SOME options you actually would be very, very happy if they expired worthless. These are those situations:

1) If the option was shorted by you, as in the case of writing a covered call or a ‘naked’ put, or:

2) The option was not meant for profit but as a hedge, as in a spread or a married put.

In the first case, the happening of an option expiring worthless is a relief. It represents the end of an obligation, and that the money received for taking on the obligation has been successfully ‘banked’.

In the second case, it may be that the option expiring worthless is a GOOD thing that may be chalked up to the cost of doing business.

For example, if an investor were to buy XYZ at $50, and as a hedge also buy an XYZ June $55 put for $7.50, his total cost will be $57.50.

Should XYZ go to $70, the profits would be ($70 – $59) = $11, or 19.13%. The stock alone was a 40% gain, but the put has expired worthless,

On the other hand, if XYZ falls by 40% or so, the put option will stop our investor’s losses right at his total cost minus the strike price, or ($57.50 – $55) = $2.50, or a 4.34% loss.

I believe that in the above scenario, reasonable folks would be much happier surrendering half of their gains if it meant limiting their losses to such a miniscule amount in the case of disaster.

At the prospect of losing 4.34% or making 19.13% on the same size movement in the stock, allowing one’s put option to expire worthless would actually be something to hope for.

IMHO, it;s like investing in the xgd or in risky venture stocks. Limit options to 5 % of your portfolio and you should be fine.

I read a good book on options by Micheal Thomsett and a good book on options put out by the montreal exchange. Again, just my opinion. Best Regards—Joe

IMHO, if you can progress to level 3 or 4 options then your chances of making money might be greater. You would be collecting the premiums of buyers and sellers instead of relinquishing them.

Thanks for your contribution. Although I have a question about the RIM example- you mention that it finishing in the money is 100% due to price, time and implied volatility. Isn’t implied volatility just the “implied” volatility based on the price of the option?

Cheers

I’m glad you mentioned that ’80% of options held to expiration expire worthless.’ That 80% is figure is quoted frequently, without your disclaimer. It’s a very misleading number. No one knows for certain, but many of the options that have any intrinsic value are closed prior to expiration. Thus, the options held all the way tend to be worthless. Bottom line: nowhere near 80% of the options written expire worthless.

I’d like to clarify another point. If you hold an option until expiration, the price you paid is 100% IRRELEVANT when it comes to deciding whether to exercise an option. In your example above, if the stock finishes at 50.29 no one would allow it to expire worthless. Even if you paid a whole lot more than $0.30 when you bought the option, why throw away that $29 of intrinsic value? Why lose every penny you paid for the option when you can salvage $29?

RIMs probability of finishing in the money has noting to do with that 80% figure. It’s 100% related to the stock price, time remaining, and implied volatility.

One last point: If an option has a 20% chance of finishing in the money, the chances of making a profit are less than that. Part of the time the option does not move far enough in the money to compensate the buyer for the premium paid.

http://www.mdwoptions.com

http://blog.mdwoptions.com/options_for_rookies/