Is Writing Options Profitable?
One of the most important questions option traders want to know – is writing options profitable as a trading strategy?
The answer is yes, writing options can be a profitable trading strategy, but it depends upon how you structure the trades. If you write an option without structuring it properly, then you’ll reduce the chances the options you wrote (or sold) will make money. Hence it really depends upon the skills of the option trader.
In this article we’ll explain what an option writer is, how does the writer of call options make money, how does the writer of put options make money, how do option writers lose money, how much money you need to write options, and what is the maximum profit that a call option writer can earn.
Let’s jump in.
What Is an Option Writer?
A trader who is an option writer is someone who sells an option contract in exchange for collecting the premium. Who are the option writers collecting the option premium from? The option buyer who pays the premium.
Anyone who writes options can sell call options, put options, or any combination of options that results in them being a net seller of options.
If you write an option by selling a call option, you get the premium up front for the value of the call you sold. In exchange for collecting the premium, you take on the risks of that call whether its covered or uncovered. The same goes for selling puts.
Hence an option writer is simply a trader who sells (write) the option or a group of options that are collecting net short.
It should be noted anyone can technically buy or sell (write) options assuming they have the permissions from their broker to do so.
How Do Option Writers Make Money?
Option writers (who sell options) make money by a) selling options that expire worthless (to the option buyer, thus allowing you to keep the full premium) or b) by closing the option for a partial credit of what you received.
For example, let’s say you sell one call contract on the $SPY (S&P 500 ETF) expiring this Friday at the 430 STR (strike) for $3.50 in premium. Once the trade is fulfilled, you immediately get the $3.50 credit in your account which = $350 (1 contract x 100 shares per contract x $3.50 in premium = $350).
Now if the $SPY never gets above the 430 STR by the time of expiry this Friday, the call you sold expires worthless and you get to keep the full premium. This is the best scenario as you keep the full credit for the option you sold (wrote).
But let’s say the market starts to get close to the 430 STR by Friday and you’re worried it may continue to gain in price and close above 430 by the expiry. Well, you can close the call you sold early for the value of the call at the time you want to close.
If you sold the call for $3.50 in premium and the call is currently worth only $2.00, then you can buy back the call for $2.00 pocketing the difference which is $1.50. This is because you sold it for $3.50 and yet bought it back for $2.00, thus making a $1.50 profit, or $150 per contract.
The advantage of closing it early for a guaranteed profit is that you eliminate the risk (or possibility) the $SPY closes above the 430 STR and is worth more than the $3.50 you sold it for. Hence you avoid a potential future loss by locking in a smaller guaranteed profit. And with American style options (*which most people trade) you can close them any time after you open them. Hence if you’re ever worried your option may become a loss, just close it early for a profit and move onto the next trade.
This is how the writer of a call option makes money.
But how does an option writer of a put make money?
Virtually the same way. Let’s work with another example in Apple stock ($AAPL) which you think will hold above the $150 support level by this Friday. You can (as an option writer) sell a put at the $150 strike expiring this Friday.
Let’s say the value of that put is $2.25. By selling that put, you collect $2.25 in premium or $225 per contract.
Now if the price of Apple closes at or above the 150 STR by the Friday expiration date, you get to keep the full premium of $2.25 or $225 per contract.
But what if the stock price of Apple falls to $151 a few hours before the Friday expiry and you’re worried the stock may fall below the 150 STR?
You can close the put you sold by buying back a put for the current price. Let’s say the current price of that put you originally sold is now worth $1.75 in premium? You can buy back the put for $1.75 in premium and pocket the difference of 50c per contract (or $50 per contract). This allows you to avoid a future loss, close it for a lesser profit and negate the risk of a loss.
Hence the way you make money writing calls is virtually the same way you make money writing puts.
How Do Option Writers Lose Money?
Now that we’ve covered the ways you can make money writing options, its important to cover the ways you can lose money writing options.
Let’s go back to the $SPY call you sold for $3.50 at the 430 STR.
If you remember, you get to keep the full $3.50 credit if the call option expires worthless, which it would if it closed below $430 by expiry.
But what if $SPY starts a bullish trend and is above the $430 STR by the expiry, say at the 433 STR?
Then the call you sold for $3.50 to the buyer would be worth more than the price you sold it for. Let’s say the call is now worth $4.50 at expiry. If the buyer did not exercise it and held it through to expiry, you would have to pay the difference between what you sold it for ($3.50) and what it was worth at expiry ($4.50) which would be a net of -$1.00.
Hence, you’d lose $100 per contract you sold. If the price was $5.00 at expiry, the loss would be $1.50 in premium, or $150 per contract.
Thus, you can lose money at expiry if the contract is worth more than you sold it for.
Another way you can lose money is by closing it early for a loss.
Let’s say it’s one day before the expiry and your 430 STR call that you sold for $3.50 is now worth $4.00 and you’re worried it may continue to go against you?
Well, you can simply close it for the value of the call option now. If it’s worth $4.00, and you sold it for $3.50, then you’d lose the difference of 50c per contract (of $50).
Essentially, there are two ways you can lose money writing options, by a) holding the option till expiry and the option you sold is worth more than you sold it for, thus paying the difference, or b) closing it early and paying the difference between what you sold the option for and the higher value it has when you close it.
There is a third way which has to do with being ‘assigned’ but that is for another article, but you now know the two main ways you can lose money writing options.
How Much Money Do You Need to Write Options?
Now that we’ve covered using simple examples how option writers can make and lose money selling calls or puts, an important question needs to be addressed of how much money do you need to write options?
The answer is…that depends. There’s no fixed amount of money you need to write an option per se, but you will need at a minimum the margin required to sell an option if the option is not ‘covered’.
What Does ‘Not Covered’ Mean?
When you sell a call, you are selling the call on a particular stock at a particular price (called the ‘strike’) on a particular end date (called the ‘expiry’).
The buyer of your call is buying the same call at the same strike for the same expiry. But the buyer of the option has a ‘choice’ with their option. They can at any time a) close the option for a profit/loss before the expiry, b) hold it till expiry, or c) ‘exercise’ the option.
The latter (exercising) the option allows the buyer of the option to convert their call option in a long share position on the stock.
At what price can they buy the stock with the option? At the strike they bought the call. Hence if they bought the call at $100 and the stock closed at $110 at expiry, and they ‘exercised’ it, by exercising it, it converts their long call option into a long stock position at $100 with them being long 100 shares per contract they bought. If they bought one call, they would be long 100 shares at expiry if they exercised it.
You on the other side of the call (if they exercised it) would be short the stock at the $100 price by 100 shares per contract.
Now if you don’t currently own at least enough shares to cover the call you sold (1 call = 100 shares) then if you don’t own at least 100 shares of the stock at or below the strike price ($100 in this case), then the call is considered ‘naked’ or ‘not covered’.
If, however you already own enough shares to ‘cover’ the call, then when the call you sold is ‘exercised’, your shares will ‘cover’ the call you sold, and will be exchanged 100 shares for the 1 call contract you sold. Thus, by being ‘covered’ in this case, you do not incur any loss if the stock closes above the $100 strike and is exercised.
Now circling back to the amount of money you need to ‘write’ options, if you have enough shares to ‘cover’ the call you sold, then you don’t need any additional margin to write the call. But if you don’t have enough shares to cover it, then you’ll need to put up the necessary margin required for that specific call, which will vary dependent upon the stock price, the value of the option and size of your position. Make sure to check with your brokerage account how much margin they are requiring for writing the call or put.
Hence, there is no fixed answer as to how much money you need to write options as its highly dependent upon the options you are writing, the stock price and the size of the position.
As a general rule, we’d recommend not selling or writing options till you have at least $2K in your account.
Is Option Writing Always Profitable?
While option writing can and often is profitable, especially if you structure the trades correctly and it goes in your favor, there are times writing options will not be profitable.
You’ll need to know what variables can and often do lead to writing options and losing money. A few examples of these variables which can hurt your options writing trades are:
- Are the options cheap or expensive relative to their historical volatility?
- Is the implied volatility of the option gaining or losing value over the recent time period?
- Are there earnings/events coming up which would likely increase the value of the options?
There are many more variables which can affect options pricing and whether the options you are writing/selling will likely make or lose money.
To list all the variables and explain the how/why they can hurt option writers is beyond the scope of this article, but just understand not all options you write will be profitable as many can lose.
But by avoiding the common ways they lose money and structuring the trades in ways they’ll likely make money, you can increase your accuracy and chances of making money consistently writing options.
If you’d like to learn how – make sure to check out our options bootcamp where we explain the ways each strategy can make or lose money, how to maximize the option strategies profitability, and what are the best price action patterns to combine when writing options.
Do 80-90% of Options Expire Worthless?
There is one common myth you’ll hear that 80-90% of all options expire worthless. This myth is not accurate and misstates the actual statistics around options.
There were statistics published by the CBOE (Chicago Board of Options) which stated that only 10% of all options were exercised. But just because only 10% of all options were exercised does not mean the remaining 90% of the options expired worthless.
According to the CBOE, between 55-60% of all option contracts are closed prior to the expiration. This basically means that for every 100 contracts sold, about 55-60 of them will be closed early instead of being held to expiration.
Thus, if 10% of all contracts are exercised, and 55-60% are closed early, that means roughly 30-35% of all contracts expire worthless. Hence it is not accurate to state over 80-90% of all options expire worthless as only 30-35% do.
Now the real question is how many of those 55-60% of options that were closed early were closed for a profit? And what about the 10% that are exercised?
Lamentably, we don’t have those statistics about the 55-60% that are closed early. It’s also important to note not all of the 10% of contracts exercised are done for a profit.
Thus, we simply don’t know the exact details. But now you do know that if someone claims 80-90% of all options expire worthless, that they are not accurate in making this statement.
What Is the Maximum Profit That a Call or Put Option Writer Can Earn?
Technically there is no fixed answer for this because the values of calls and puts that are sold are unique to that option. One could sell 10 calls for $150.00 in premium which would be $150 x 10 contracts x 100 shares/contract = $150,000.
Yes, you can do this assuming you have the shares covered or the margin to do so.
The real answer to this question is anyone who writes a call or put option can earn the full credit or value of the option they sold. That is the maximum profit a call or put option writer can earn, but that total profit will depend upon a) the value of the call or put option they are selling and b) the number of contracts they are selling.
Hence, whatever the premium you are selling the call or put option for is the maximum value you can earn on that trade. There is no more money to be made than the premium you collect for selling that option.
To Recap
In this article we have answered the important question of whether option writing is profitable, what is an option writer, how does the writer of call or put options make money, whether options writers lose money, what are ways to make option writing profitable, how much money you need to write options and what is the maximum profit you can make writing options.
There are many reasons to write or sell options which we’ll cover in a later article, but you can’t simply write options and expect to print money. You have to learn the risks and ways writing options can make and lose money.
Once you learn these methods, along with how to ‘structure’ your trade, you can increase your accuracy and profitability in writing options to generate income regularly.
Lots of traders decide to only write or sell options. While we think this approach has some benefits to it, it also has its pitfalls.
If you’d like to learn when to write and when not to write options to generate profits regularly, check out our options bootcamp where I teach you the tips and secrets of when to write, and when not to write options profitably.