If I search positions by probability of profit, is that usually accurate? I know it depends a lot on market activity, volatility, direction, etc. but is it safe to say high probability of profit percentages are pretty accurate in the position finishing up that way. Do people take positions just using prob of profit and are successful with it?
Probability of Profit projections usually make assumptions regarding the underlying remaining in a certain trading range, or taking a particular direction. And those assumptions can never be made with any degree of certainty. There are just too many market forces and other variables at work.
You have to understand that option pricing is done by the floor market makers, and that they will move the "Implied" Volatility based on supply and demand. Your probability of profit is based on whatever volatility you decide on. You then are simply guessing what next monht's or next year's volatility actually is. There are other factors of course, but primarily it's betting on what the volatility "will" be, not what it is or was. Pretty tough to do these days. Check the VIX from July to September, LOL - almost blew out some very large firms. Don
thanks for your input, one more question, If I know a stock will move, but I dont know the direction and volatility is low, whats a good strategy to play? The trade should last a few weeks max thanks.
Best strategy is to turn your crystal ball off, LOL - sure it will "move" they all do, but how much do you want to pay for guessing how far it will move. (But, to answer). Stock is $30.00 and you "know" it's going to move. The calls and puts are $3.00 each. You buy the Straddle for $6.00. You don't make any money unles the stock falls below $24 or above $36. Quite a move for low volatility stock. "Options as a Strategic Investment" by Larry McMillan is a decent start. There are more sophisticated books out to follow up with. All the best, Don
A low volatility stock shouldn't have short-term options anywher near that expensive. The straddle would in reality be much cheaper to open and would profit much sooner. Depending on the option prices and the size of the expected move, that might be a worthwhile approach. You can cut your costs a little bit by writing a strangle around your straddle and converting it to a butterfly. You should still experience a high rate of return if the stock makes it all the way to the "wings" of the butterfly. Another approach if you think the stock is moving away from a strike price is the reverse calendar. Buy a near-term ATM option and write a longer-term option at the same strike. The position is opened for a credit. If the stock moves far in either direction, the option prices will converge (either to zero or to parity) and you can hopefully get out at a profit.
It was just an example to show how a straddle works. It's all about volatilty, of course. I find it interesting that all the things we did on the trading floor from 1979-1990 for quarters and more (straddles, strangles, butterflies, condors, iron condors, conversions, reversals, calendars, verticals, boxes, etc. etc.) are still being done for pennies. We didn't' have the whole world with the same analysis programs (we helped set up Blair Hull's "Option Research" methodologies "back in the day").... so we were able to price things pretty much the way we wanted, within reason of course...I don't see that being done much any more - the MM's and institutions seem to value all the conversions within pennies these days. It's kind of neat seeing that "the more things change, the more they stay the same." Anyway, good luck and good trading!! Don