Reiner & Rubinstein, 1991 The actual closed form formula is given in the Collector's (Espen Haug's) book, among others. That was in response to how to determine the risk-neutral probability of hitting a barrier.
I use ToS's (ThinkOrSwim's) version. It was the closest to the estimate I developed using Monte Carlo methods. Which is the one I developed after developing a Markov Chain approach. ToS maintains that their formula is proprietary and I have not looked at MG's references to verify what he suggests is the equivalent closed-form expression. It is a subject of huge debate (sometimes with significant venom) on whether this metric provides a trading edge. I cannot say. I can tell you that it is my key to choosing the short strike for my spreads. Many here suggest that I will eventually blow up if I continue to rely on it. I stubbornly persist. Sorry to bring along so much baggage with my answer. I did so in the hope (but not the certainty) that we can avoid the rehashing of the arguments we have had in other threads. You can see the beginnings in some of the previous posts.
As I mentioned to you before, Howard, it doesn't matter if the technique is based on Monte Markov Chains or whatever (underlying assumptions matter, not the method). The concept has certain flaws, by construction, which make its indiscriminate use in practice dangerous. It's sorta like what they say about Black-Scholes vol (which you use implicitly in your calculation): it's the wrong number that, when plugged into the wrong formula, gives the right answer. Your PoT is a number of precisely the same kind, by definition.
fark man, why is everyone beefing on howard. Whether or not Howard has a flawed approach on options trading, he has a better understanding of options than most people on this forum, including the thread starter Maverick 74. The thread starter sold an options put spread with 10 point difference in SNP and lost 1.25 points today on the selloff, it touch his short strike with about 3 weeks left til expiration and he is sh!itting his pants. We should be helping the thread starter, not Howard.
No, I only trade the weeklies. I took the position on Wednesday for a... 20 stinking cent credit. I got .60 cents for the 1295's, only to see it open at about 3.50 this morning. I get 20 cents and would have to cover at over 2 dollars. Made me sick to my stomach, or bonza as we say in Sicilian. Here I am thinking, Jesus, if I'da been long them sumbiches.... My usual MO is to take a position on Monday as far out of the money as possible and still get about a .25 cent credit at least on a 10 dollar spread, and crap in my pants the rest of the week hoping it will expire worthless at the end of the week. I'm up 30% on available funds in 6 months, with my only screw up being the unrest in Egypt in...Feb, Mar?. It's infantile, I know...but the Greeks just don't sink in, so they don't help me...right now this is the only game I feel comfortable with, I'm such a one trick pony.
I agree with you completely on the use of this tool or any tool for that matter. One must understand its limitations which are usually in the assumptions. I only threw in Monte Carlo methods and Markov Chains to amuse you. I did in fact, do those studies, but it is of little consequence to understanding the use of and limitation of PoT as one of the selection criteria for the short strike of a spread.
You are up 30% in 6 months. That is admirable. What is troubling is that you have not communicated your short strike selection criteria other than a .25 credit on a $10 spread. If that is your key selection criteria it exposes you to different levels of PoT risk depending on factors such as IV. If you are doing this it's like flying with only half your instruments working. Possible, but more risky. You might begin learning something about the Greeks by noticing how they change while you are in the spread. Also notice what they are when you enter the spread. Then compare what they were with the results you got. It may not give you a deep understanding, but it may give you some practical tools to help select and manage your spreads without knowing how the work. Lastly, I like to sleep well at night. So I try to select my short strikes to give me the minimum of sleepless nights. Hope is not part of my strategy. Discipline is more important and more conducive to sleeping and requiring fewer aspirin.