Probability and April Put-Spreads

jkgraham · Apr 11, 2011

I was thinking of selling some April Put-Spreads since there was only five days left. The Investools option screener brought up: GOOG (earnings due this Thur.), AAPL, AMZN, PCLN and SBUX. The PCLN April $490/485 Put Spread has around a 15% return. The Investools Probability Calculator reported a 16% chance that PCLN would drop below $490 in five days. I was excited at first and almost placed a trade but I noticed that PCLNâs support and 30-day MA are around $475-480.

Moral of the story is Investools Probability Calculator is a dangerous tool. The option screener worked fine.

What is the best way to judge the probability of a trade such as the PCLN $490/485 Put-Spread? (Or the $470/465 Put-Spread which has about a 4% return)

spindr0 · Apr 11, 2011

Quote from jkgraham:

I was thinking of selling some April Put-Spreads since there was only five days left. The Investools option screener brought up: GOOG (earnings due this Thur.), AAPL, AMZN, PCLN and SBUX. The PCLN April $490/485 Put Spread has around a 15% return. The Investools Probability Calculator reported a 16% chance that PCLN would drop below $490 in five days. I was excited at first and almost placed a trade but I noticed that PCLNâs support and 30-day MA are around $475-480.

Moral of the story is Investools Probability Calculator is a dangerous tool. The option screener worked fine.

Where support is and what the 30 day EMA are have nothing to do with the probability of breaching a strike. What's dangerous is the tool who executes option positions that he doesn't understand or takes on size that he can't swallow

What is the best way to judge the probability of a trade such as the PCLN $490/485 Put-Spread? (Or the $470/465 Put-Spread which has about a 4% return).

There are lots of probability calculators out there. I doubt that any particular one is better than another since probabilty is probability. Profound, eh?

And FWIW, stay out of the way of earnings unless you have some edge.

HowardCohodas · Apr 11, 2011

I only trade index options credit spreads because I am unwilling to expose myself to an individual compay's market gap risk, like the CEO taking a leave of absence for health reasons.

I use a ToS metric called PoT (Probability of Touching) as my proxy for the chances I will have to close the spread rather than letting it expire worthless. PoT for the short strike in a credit spread is what I look at.

jkgraham · Apr 11, 2011

>" Where support is and what the 30 day EMA are have nothing to do with the probability of breaching a strike"

But doesn't support and 30 day EMA help in determining where to set a strike?

MTE · Apr 11, 2011

Quote from jkgraham:

>" Where support is and what the 30 day EMA are have nothing to do with the probability of breaching a strike"

But doesn't support and 30 day EMA help in determining where to set a strike?

If you are into that stuff then sure you can use it, however, it doesn't affect the statistical probability, which is derived from a probability distribution.

spindr0 · Apr 11, 2011

Quote from MTE:

If you are into that stuff then sure you can use it, however, it doesn't affect the statistical probability, which is derived from a probability distribution.

As per your initial post, you sell the PCLN 490 put.

Situation A: Support is at $480

Situation B Support is at $460

Is the probability of breaching the $490 strike any different in these two situations?

From the ridiculous to the sublime... The 30, 50 and 100 day SMA's, EMA's and weighted MA's are at $470 along with a MACD crossover, a 20% stochastic and an inverted double cup and handle mutliple doji candlestick hogback growler. What''s the probability of breaching the $490 strike?

HowardCohodas · Apr 11, 2011

Quote from spindr0:

As per your initial post, you sell the PCLN 490 put.

Situation A: Support is at $480

Situation B Support is at $460

Is the probability of breaching the $490 strike any different in these two situations?

From the ridiculous to the sublime... The 30, 50 and 100 day SMA's, EMA's and weighted MA's are at $470 along with a MACD crossover, a 20% stochastic and an inverted double cup and handle mutliple doji candlestick hogback growler. What''s the probability of breaching the $490 strike?

The April 11 PCLN 490 PUT has a probability of touching (PoT) of 39% using the fixed volatility per expiration date volatility strategy. Not my comfort zone.

jkgraham · Apr 11, 2011

Quote from spindr0:

Situation A: Support is at $480

Situation B: Support is at $460

What''s the probability of breaching the $490 strike?

I say the probability would be lower in Situation A. But good in both cases. However, I'm about to start placing Put Spreads above the support.

If you were going to set up a PCLN April Put Spread where would you set the Short strike?

I continued to look at the othe PCLN April Put-Spreads and as I moved down when I got to the $470/465 area the return was around 4%. Which was also the return for BLK, AAPL, AMZN, SBUX just under their support levels as well. Humm.

jkgraham · Apr 11, 2011

Quote from HowardCohodas:

The April 11 PCLN 490 PUT has a probability of touching (PoT) of 39% using the fixed volatility per expiration date volatility strategy. Not my comfort zone.

How can I find the PoT using a the fixed volatility per expiration date volatility?

HowardCohodas · Apr 11, 2011

Quote from jkgraham:

How can I find the PoT using a the fixed volatility per expiration date volatility?

PoT is a proprietary metric available from ThinkOrSwim. I first became acquainted with it during the five months I paper traded before funding my account there.