BUT, HELP ..."The difference between the strike prices defines the maximum value of the spread. For this position it is 7 points and with a cost of 2.95 there is a potential gain of 4.05 for a risk to reward ratio of .73, or the potential gain is 1.37 times the defined and limited risk." the ratio is easy to figure... but what is the last part of the process?? tooo me it means for each dollar risked you could gain 1.37$.. is that correct? how does this equation work out mathematically? thx all
1) This is the last part.......you're not taking into account the probabilty of the best and worst case scenarios happening. What's the likelihood of losing the 2.95 point premium? What's the likelihood of earning the maximum 4.05 points of premium? 2) Yes. 3) Besides the extreme scenarios, you have to take into account the likelihood of the other P&L scenarios in between. The delta of the option is a simplistic guideline. An at-the-money option has a 50% chance of being in-the-money by expiration.
Whoever wrote it is just getting a little fancy with his math. Short answer to your yes/no question is "yes." 1.37 = 1/.73 reward/risk = 1/(risk/reward)