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Let's Use Pot (Probability Of Touch)

Dec 11, 2015

We're not afflicted with Reefer Madness when we advocate using POT since our POT is an acronym for Probability of Touch and knowing those probabilities can help your trading. All traders, not just the burnouts, will benefit from the info here.

When examining out of the money options the probability that the price of the underlying will touch that strike is roughly 2x the probability that the option will expire in-the-money (ITM). This can be tested by looking at how often a 1 SD strangle touches either strike versus how often it expires ITM.

A study was conducted examining the SPY (S&P 500 ETF) over the past 20 years to determine how often 1 standard deviation (SD) strangles expired either in the money (ITM) versus touching either strike before expiration. A table of the 1 SD strangles since 1995 and since 2014 was displayed. The table included when the percentage of the SPY strangle trades expired ITM and the percentage of the SPY strangle trades that were touching either strike.

Using the information that POT is 2x the probability of expiring ITM, why can’t we buy an option and sell it for a profit when it approaches our strike? We first explain the problems with this strategy and then provide examples.

Two examples of going long strangles and comparing the price of a strangle to the price of the strangle when one of the strikes has been touched was displayed. The table included two ½ standard deviation short SPY strangles, one when the call side had been breached, and one when the put side was breached.

Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the takeaways plus other information on using probability of a touch (POT) and how this can help our trading.

This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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