Registered: May 2009
06-24-12 06:52 PM
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%.