How do I determine odds in a credit spread?

How does a "way out there" spread have a Delta of -.98????

I'm assuming you mean -.02



dcwriter2 said:
I'm tinkering with the Kelly formula and it makes sense except when it asks me for the odds. Does that mean if I am writing a spread with delta of -.98, way out there, my odds are 1:98 and how is that expressed in a percentage or decimal?
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MrMuppet said:
That's a good way to blow up your account^^

The "odds" you're talking about are implied by the options prices...and they don't necessarily mirror your true odds. The true return distribution is unknown and you're betting against it by buying cheap implied distribution and selling expensive distribution via options.

If you're selling cheap "odds" against expensive realized distribution you trade at negative edge. Add full Kelly to it and your risk of ruin is 100%
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Are you saying Kelly only works when you stand to gain more than you are risking?
 
dcwriter2 said:
Are you saying Kelly only works when you stand to gain more than you are risking?
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Kelly works when your expected value is positive and your odds are fixed. When you trade options, your odds are unknown and when you sell lower than actual odds you trade at negative expected value
 
When I have to measure the risk amount of a credit spread, I consider the width of the spread and subtract the credit amount from it.
 
dcwriter2 said:
and the delta should give you a rough estimate of the odds, right?
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No. That's where you and probably 90% of retail are wrong. Delta gives you the odds that are implied by the option. But true odds cannot be known.

Your bet is: "the option implies 25% odds on a strike touch while my guess is that in reality the odds are 35%"

That's it. That's your trade.

Delta changes with implied vol, so if we take above example, you buy the call at 25 deltas and 30% implied vol. You can now win in two ways: Either you're getting your strike touch and you underpaid for it. That's a win via delta/gamma as you make money because the underlying went your way.
OR the market realizes the option was too cheap and adjusts the probability from 25% to 35% by bidding up the option without a move in the stock. So you win via implied vol as delta (and thereby the odds) increases with implied vol
 
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