An Important Lesson for All Options Traders

Posted On April 24, 2020 1:23 pm
By: Steve Smith

One of the persistent and pernicious myths regarding options is that 80% of them expire worthless. The number belies the fact that most options get closed well before expiration and can create some misleading belief that selling premium is the only sure way to make money trading options. In the current volatile environment, using options on the assumption that they will expire worthless is especially risky and can lead to large losses.

Given the big price swings, I don’t care how far out-of-the-money or how little time is remaining, there’s no guarantee the option will expire worthless. And those that stay short on puts or calls trying to collect the last 10c or 15c of premium are creating a situation of extreme asymmetric risk/reward that can result in financial ruin.

Just this past Thursday during the final hour of a regular trading session, “Gilead (GILD)” saw an unusual flurry of options activity with buyers scooping up some 7,500 contracts of the 80 strike calls for a mere $0.15 per contract, which were set to expire the next day.

Just after the market closed a reporter leaked the early results of GILD’s Remdesivir treatment for the Covid-19 virus in STAT magazine.

GILD shares popped to $86 in the aftermarket and those 80 strike calls went from 15c to $6.00. Big win for the lucky bunny with a sharp nose. But huge losses from those that had sold those calls short. Remember, options are a zero-sum game in that for every buyer, there needs to be a seller to create a new contract of open interest.

Similarly, in the… Continue reading at StockNews.com

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.