Again I think that this is an oversimplification that cannot be applied to ITM options. A $40 strike call on an $80 stock is not going to be tested at least once, it is already ITM.
Option math question
- Thread starter levijean
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Again I think that this is an oversimplification that cannot be applied to ITM options. A $40 strike call on an $80 stock is not going to be tested at least once, it is already ITM.
Look at the calculation and the solution itself - (POT) Probability of Touch for an In-The-Money option is 100%. It's not asking how many times can you expect it to Touch before expiry. This becomes relevant for an OTM option in terms of understanding the risk. Its just one measure of 100 to give some assurance that the risk is measurable when in reality it's not...just a probability to give some context to describe the strategy relative to risk.
For ITM options, instead of touch, I would be more interested in probability of stock price touching breakeven. I think this method allows me to assess my trading risks.
Great discussions.
Regards,
That may be quite difficult because breakeven is not a strike price, it is based on what your debit/credit is. For example if you buy a $50 Strike Call at $2.00 with the stock at $45. Your breakeven is hard to predict at what point in the future except at expiration. Since you could make a good profit well before expiration date you could be above breakeven even if the stock stays at $45.
That is why I raised the issue of using delta *2 for surrogate of probability of touch and said it might only serve for OTM options since ITM options, what relevance does touch have really.
I think even touch has no bearing on profit or loss because a stock could touch your strike and you still lose money on a long call. I just caution against getting bogged down on these probabilities that come from a formula giving an instantaneous value based on false assumptions. Even using delta as a surrogate for probability of expiring ITM is fleeting and just a general idea.
So, how do I calculate the probability of touch of (strike + premium)? Can't I use Black Scholes with some assumptions of IV and remaining expiration time?
Thanks.