Relation between delta and SD

Discussion in 'Options' started by SumZero, Jul 19, 2018.

  1. SumZero

    SumZero

    SPY currently at 280

    Call 290 15/Aug shows a delta of 6.5

    Having delta as a proxy of ITM probability, this means 6.5% of expiring ITM.

    How’s the chart showing 15.17% of having the price above 290 ?

    I'm not getting the relation between 6.5% and 15.17%.

    SPY.JPG
     
    stepandfetchit likes this.
  2. tommcginnis

    tommcginnis

    If you look on the other side, you'll notice things are a lot more cozy between the declared delta and the P(ITM). (Like, nearly exact.)

    Why would the puts be adhering to a Normal-ish distribution, and the calls seemingly so stingy?

    Or is it that the market does not "believe" that the underlying will/could march that far north?

    "B-School" conventional wisdom is that returns are log-normal distributed (right-skewed) because things move in percentage terms, and prices are bound by $0. (And, we can usually stretch this from returns to prices without too much headache...)

    But in practice, we must deal every day with a left-skewed world. :rolleyes:


    [​IMG]


    Welcome to "skew."
     
    Last edited: Jul 19, 2018
    TradingDemystified and SumZero like this.
  3. SumZero

    SumZero

    You're right. On put 270 delta is 14.73 and PITM is 14.4
    Thanks for the explanation.

    SPY2.JPG
     
    tommcginnis likes this.
  4. Analyze/Risk Profile on ToS is a very very helpful tool however a well known "flaw" is that when calculating the risk profile graphs it uses a flat IV (in this case it uses the stock's IV: 12.73%) to calculate the estimates of Probabilities. In the case of your call that particular strike/expiration has an IV of 8.25% (calculated from bid/ask) so there is a very large difference because of skew (like @tommcginnis mentioned). The 270 put in your other example has an IV of 13.18% which is closer to what ToS is using to calculate the probabilities and that's why it's more accurate

    TL/DR ToS Analyze assumes there is no skew in calculating probabilities while in real life there is IV Skew (across strikes with same expiration) and term structure (in different expirations)
     
    SumZero likes this.
  5. The implication from the response posts are that using a probability cone for price range of underlying may have room for improvement.
    Incorporating Skew (and term) into the equation should improve the results. (The 800# Gorilla in the room).
    Please post this "improved" probability cone TOS ThinkScript study for general consumption! ;-) -- (A bit of a joke, until TOS supports options better via ThinkScript)
     
  6. tommcginnis

    tommcginnis

    Let's remember that IV is derived from the option market, not the other way around.
    We all use IV to develop other numbers (like "expected move") but we have to remember what exogenous to our set-ups and what's *endogenous*, or we'll end up in some great logical difficulties. So, "IV" does not give us deltas or P(ITM)s, though we might wish....
     
  7. destriero

    destriero

    Premium in, IV out. Along with greeks. Where do you get your greeks from...?