Implied Volatility is a Future Indicator, yes. But this contradicts what jnbadger said about the calculation being based on the past 12 months' Standard Deviation data.
They are useful to give a picture of volatility in terms more easily understood by normal humans. I like to look at them but always in conjunction with technical analysis. If something looks like it is topping a trading range, you would not want to sell a "95%" put spread. These kinds of probability calculators are usually using standard deviation and a normal distribution. Stock prices aren't random every day. They go in a direction. Always try to identify a trend and use that in conjunction with the probability. The probability on its own is no good.
Indeed. When I look at a long term chart, my eye goes right to the support and resistance levels. Those levels are where actual traders bought and sold, for all kinds of different fundamental, technical, and emotional reasons. Below and above those levels is where I want to sell OTM Options (in Credit Spreads and Iron Condors), irregardless of what the Probability % numbers say.
<<< If something looks like it is topping a trading range, you would not want to sell a "95%" put spread. >>> Exactly my point. It's a "lazy and risky" substitute for doing a thoughful and common sense analysis.
I agree with your approach. Feel much more confident with Trends, Support and Resistance Levels, and factoring in Macro Economic and World Events, etc., and then afterwards checking the Probability %. Yet some traders mechanically set up there Spreads and Condors based on "80%+ Probability" for each leg, etc. Perhaps they back-tested it over 100 trades and found they profited 80+% of the time doing it that way? I suppose that's possible. To each his own.
No, he's right. In a way. It's based on current implied volatility. That's why the shape of the cone will change if you mess with the IV settings. But you need some data to make the computation in the first place, right? You can't compute standard deviations without past data.
I wish someone like atticus would say something. Like I said, I'm pretty good with options knowledge, but I have this strange feeling in my gut like I don't know what the hell I'm talking about.
For further confusion I went to thinkorswim Support! cman: We're currently have a discussion on Elite Trader Forum about your OTM, ITM, Of Touching Probability Calculator. No one quite agrees on how you come up with the % numbers. Could you shed some light on this for us? Mike: For the probability of expiring it is basically the delta of the option. In most cases the two numbers are very similar, they are normally a few points apart. The probability of expiring is the chance that the option will be worth one penny at expiration. It is a statistical measure which is why it may not be the same as the delta which varies with interest rates and IV changes. cman: Historical and Implied Volatility and Standard Deviation are involved how? Mike: I would look up formula for delta on the internet, as we do not provide them. Another source would be Don Kaufmann. His e-mail address is dkaufman@thinkorswim.com :eek:
Just checked, and the Prob. ITM is roughly the same as the Delta - though sometimes it's off by 3+ points.