I have noticed a lot of emails cycling through my inbox and questions posed by some of my students that are touting the high (almost guaranteed) profits that can be made in credit spreads. Claims like “personal monthly ATM machine”, 90% chance of profits, etc. If it is too good to be true, is usually is right? You can be profitable trading credit spreads, you can be profitable trading debit spreads. To categorize yourself as one or the other is just misguided. The big logical fallacy lies with this: The claim is that 90% of options expire worthless, and that therefore it is better to be a seller of options than a buyer of options.
This claim misstates a statistic published by the Chicago Board Options Exchange (CBOE), which is that only 10% of option contracts are exercised. But, just because only 10% are exercised does not mean the other 90% expire worthless. Instead, according to the CBOE, between 55% and 60% of options contracts are closed out prior to expiration. In other words, a seller who sold-to-open a contract will, on average, buy-to-close 55-60% of the time rather than holding the contract through to expiration. The seller’s profitability of this 55% to 60% cannot be known.
So, if 10% of options contracts end up being exercised, and 55-60% get closed out before expiration, that leaves only 30-35% of contracts that actually expire worthless.
This is a far cry from 90% and certainly no reason to build a trading methodology around it. When I consider a signal, I go in with open eyes and allow the data to determine my bias. I do not go into a potential signal with the preconceived notion that “I am looking for a credit spread to sell”.
