Have read on many occasions in the past that most of the options in the F&O market expire worthless. However, I dont have any data to support / test this claim. But, suppose if were to go by this claim and were to assume that most of the options do end being worthless, what can be guaged from this?
The first question that we need to ask is: Who are the sellers in the Options market?
I don't think its the retail investor. I think most of the option sellers are the supposedly smart investors. If that is the case, then it makes an interesting reading of the Options market, a day before the expiry.
Lets then try to build a hypothesis, based on the above:
1. Most of the Options on the F&O market expire worthless
2. Most of the Options are written by smart investors
3. Thus, we can say that Smart Investors write most of the options, which also happen to expire worthless
4. We know that every trade has a buyer and a seller. Thus, options with highest volumes are also the ones which have maximum Smart Investor interest, since they are the ones who write most options.
5. Since Smart Investor interest is the highest in top traded options, they must be on the sell-side, since it is highly unlikely for retail investors to sell options, in any case, and that too on the penultimate day.
6. Thus, top traded options on the penultimate day reflect Smart Investor's outlook for the market, the following day.
The top traded options on 25-July-07 (for July expiry) were:
1. CE 4600 (SP) - 36,802 contracts
2. PE 4600 (SP) - 29,542
3. PE 4500 (SP) - 16164
4. PE 4550 (SP) - 13023
5. CE 4300 (SP) - 11669
Put contract dominate Call contracts by a margin of around 10,000 contracts. If looked at more closely, between the SP range of 4,500-4,600, there are close to one lac contracts traded with close to 60k on the put side. Thus, it is quite likely that most of these contract will expire worthless, i.e. Nifty will end above 4,600. Infact, almost all these contracts will expire worthless if the Nifty closes exactly at 4,600 today.....we will see that in about 15 hrs from now....
contradictions / contributions, as always are most welcome !!