ThinkOrSwim's Probability OTM, ITM, of Touching Calculator

[cactiman]

Quote from heiasafari:

The calculations are based on implied volatility so what happened 6 months ago doesn't matter. Implied volatility reflects the view of option market makers of what might happen to the stock before said option expiry... Of course they can be wrong + it is well documented that extreme 2 or 3 standard deviation moves are underpriced because reality is poorly reflected by normal distribution.

Implied Volatility is a Future Indicator, yes. But this contradicts what jnbadger said about the calculation being based on the past 12 months' Standard Deviation data.

 

[gnode]

They are useful to give a picture of volatility in terms more easily understood by normal humans.

I like to look at them but always in conjunction with technical analysis. If something looks like it is topping a trading range, you would not want to sell a "95%" put spread.

These kinds of probability calculators are usually using standard deviation and a normal distribution. Stock prices aren't random every day. They go in a direction. Always try to identify a trend and use that in conjunction with the probability. The probability on its own is no good.

 

[cactiman]

Quote from Put_Master:

I was just discussing the same issue on another board.
I consider it a "lazy and risky" substitute for doing ones own analysis.
Here is what I wrote:

<<< I've been puzzlling over your 5 pt. spreads with 95%
probability outcomes. >>>


Personally, I think statistical "probability outcomes" are somewhat meaningless.
Such outcomes should be based more on common sense and thoughtful analysis, than a generic math formula.
While the formula may be helpful in getting some vague general fluctuating idea, at that particular moment in time, common sense should have already given you a general idea of the likelihood of success.
If not, you probably should not be doing the trade.
Whether the numbers calculate out to 77% or 93% chance of success is less relevant than my own analysis.

For example, assume all variables are the same on a 6 week naked put or credit spread, including 2 stocks that are both 13% otm.
But one is trading no where near any kind of tech support, and the other is once again trading at it's multi tested level of tech support, per the 1 - 2 year chart.
Given a limited bankroll, which trade would you rather initiate.
I'd make the decision based on analysis and common sense, and pick the one at multi tested tech support,... not a coin toss of statistical probabily, based on where the stock happens to be trading at that moment in time.

I'd also base it on a few basic fundamental criteria pertaining to the companies financial health. While such issues may not be very relevant in the world of option trading, I look at those criteria to evaluate whether a stock has the "potential to recover", if a bad market takes it down.
I'm less inclined to panic sell, if i know I have not invested my cash in an over valued, and/or DEBT LOADED piece of crap..... regardless of how limited the loss may be.

% probability outcome formula's, can give investors a false sense of confidence.
Nor do they speak to the likelihood of the stock recovering in a reasonable period of time, if a bad market suddenly takes it down.
Initiating a trade based on a generic statistical outcome formula, is a "lazy and risky" substitute for thoughtful analysis and common sense.

Those 95% probability outcome formulas really are meaningless.
Better to go with 96%.
<< g>>

Indeed. When I look at a long term chart, my eye goes right to the support and resistance levels.
Those levels are where actual traders bought and sold, for all kinds of different fundamental, technical, and emotional reasons.
Below and above those levels is where I want to sell OTM Options (in Credit Spreads and Iron Condors), irregardless of what the Probability % numbers say.

 

[Put_Master]

<<< If something looks like it is topping a trading range, you would not want to sell a "95%" put spread. >>>

Exactly my point.
It's a "lazy and risky" substitute for doing a thoughful and common sense analysis.

 

[cactiman]

Quote from gnode:

They are useful to give a picture of volatility in terms more easily understood by normal humans.

I like to look at them but always in conjunction with technical analysis. If something looks like it is topping a trading range, you would not want to sell a "95%" put spread.

These kinds of probability calculators are usually using standard deviation and a normal distribution. Stock prices aren't random every day. They go in a direction. Always try to identify a trend and use that in conjunction with the probability. The probability on its own is no good.

I agree with your approach. Feel much more confident with Trends, Support and Resistance Levels, and factoring in Macro Economic and World Events, etc., and then afterwards checking the Probability %.
Yet some traders mechanically set up there Spreads and Condors based on "80%+ Probability" for each leg, etc. Perhaps they back-tested it over 100 trades and found they profited 80+% of the time doing it that way? I suppose that's possible. To each his own.

 

[jnbadger]

Quote from cactiman:

Implied Volatility is a Future Indicator, yes. But this contradicts what jnbadger said about the calculation being based on the past 12 months' Standard Deviation data.

No, he's right. In a way. It's based on current implied volatility. That's why the shape of the cone will change if you mess with the IV settings. But you need some data to make the computation in the first place, right? You can't compute standard deviations without past data.

 

[jnbadger]

I wish someone like atticus would say something. Like I said, I'm pretty good with options knowledge, but I have this strange feeling in my gut like I don't know what the hell I'm talking about.

 

[cactiman]

Quote from jnbadger:

I wish someone like atticus would say something. Like I said, I'm pretty good with options knowledge, but I have this strange feeling in my gut like I don't know what the hell I'm talking about.

I really appreciate you keeping at it jnbadger.

ATTICUS!!!!!!!!!

WE NEEEEEEEEEEEED YOU!!!!!!!!

 

[cactiman]

Quote from jnbadger:

No, he's right. In a way. It's based on current implied volatility. That's why the shape of the cone will change if you mess with the IV settings. But you need some data to make the computation in the first place, right? You can't compute standard deviations without past data.

For further confusion I went to thinkorswim Support!

cman: We're currently have a discussion on Elite Trader Forum about your OTM, ITM, Of Touching Probability Calculator. No one quite agrees on how you come up with the % numbers. Could you shed some light on this for us?

Mike: For the probability of expiring it is basically the delta of the option. In most cases the two numbers are very similar, they are normally a few points apart. The probability of expiring is the chance that the option will be worth one penny at expiration. It is a statistical measure which is why it may not be the same as the delta which varies with interest rates and IV changes.

cman: Historical and Implied Volatility and Standard Deviation are involved how?

Mike: I would look up formula for delta on the internet, as we do not provide them. Another source would be Don Kaufmann. His e-mail address is dkaufman@thinkorswim.com

:eek:

 

[cactiman]

Just checked, and the Prob. ITM is roughly the same as the Delta - though sometimes it's off by 3+ points.