I love simple. Simple makes me happy. Some people will try to take a simple concept and sprinkle it with some mumbo jumbo to make it seem complicated and then claim only they can explain it to you! Don’t listen or don’t buy into any such load of bunk!
Take something like options. Yes, a lot of people, maybe even your stockbroker, will tell you options are too complicated and confusing. What they may really be telling you is options are something they don’t want to spend the time to understand, so they don’t want you to trade them either!
Today, the options world is a lot like the automobile world of 1910. Yes, lots of people have joined the ranks of options traders. But only ten years ago, it was just a privileged few investors who could take advantage of things like streaming quotes and real-time options chains. Options were shrouded in mystery and deemed too complex for the average Joe – to be traded only by the so-called “sophisticated” professional investors.
Since then, however, seismic changes in the options world have leveled the playing field for individual traders and investors. Thanks to advances in technology, innovation trading tools, and better access to what was once privileged information, the self-directed investor is now in the same position as the Wall Street fat cats were during their heyday – just a few short years ago.
So, now that we as self-directed investors have the same technology as professional traders why aren’t we applying the technology in the same way?
We all know that a stock or ETF only has a 50/50 statistical chance of success. But, what most self-directed investors don’t know is that there is a way to increase the statistical chance of success to well above 50/50. Professional traders do, and they have been using powerful technology to assist them with an appropriate strategy for years. But, as I stated before, now we have the same technology. Now it is up to use it to our advantage.
If I could choose one of the more powerful tools offered in today’s options trading software it would be the option theoreticals offered. Probability of Expiring (ITM or OTM) is the most informative data point among the options theoretical and one that I employ every day for my readers with Options Advantage.
Probability of Expiring is the chance that a stock will close in-the-money at options expiration.
So, the real question is, how can you use Probability of Expiring to your advantage?
Say, I believe that the SPDR S&P 500 ETF (SPY) is currently in a short-term oversold state and the market is due for a bounce and I want to place a trade that has roughly an 85% probability of expiring, or as I like to refer it as the probability of success.
I realize that some of you do not have access to trading software that gives you the probability of success, but any worthy trading software will provide you with the delta of any given option.
Just look above and you will notice that how close the delta is to the probability of success.
So, let’s look at how we can apply probability of expiring to the real world.
Back in December, SPY had pushed to new lows and was in a short-term oversold state. Moreover, the last two weeks of December were historically bullish.
With that being said, I wanted to place a bullish trade with defined risk with an 85% chance of expiring out of the money.
A bull put spread fits the bill.
As seen in the option chain above the 110 puts have a probability of expiring in the money of 15.59%. That means there was a 15% chance that SPY will close below 110 at January options expiration. In other words, the trade has an 85% chance of success because you want a credit spread to expire worthless by not falling below the 110 strike.
I sold the 110/108 bull put spread for $0.26 (.83 – .67) for a return of 14.9% if the trade closed at or above $110.
Not bad for a trade that has an 85% probability of success.
If you choose a trade with a lower probability of success, such as 67% (right at one std. deviation or 68%) you will be able to bring in more premium with less capital at risk. But, it is important to realize that when you give up probability for premium your chance of success declines.
Simply stated, the greater the risk, the greater the gain. You must always take that into consideration because is it worth making an extra 10% to give up 20% in your probability of success? Sometimes yes, sometimes no – it truly depends on your risk profile and conviction.
No glitz or glam here – just straight trading. Today, we’re at a special time in history. I think we’ll see options trading absolutely explode over the coming decade. Early adopters like you and I will be sitting in the driver’s seat as wave after wave of novice options investors come into the fold.
To learn more about capturing 85% probability on all of your option trades, get this FREE Special Report from Andy Crowder.