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Using a Probability Calculator


In addition to delta, these tools can enhance your risk/reward position.

Let's look at an example:

RUT is 514.92

RVX is 29.34, and we'll use that as the volatility

As of Monday morning, November expiration is six weeks or 39 days (30 trading days) in the future. The Hoadley calculator uses calendar days and the Monte Carlo calculator uses trading days.

Assume we trade the following iron condor, collecting a premium of $1.60.

NOTE: This is an example, not a recommendation, so please don't ask why I chose this IC. [It's based on the premium available, and yes, I know it's far from delta neutral]

252 trading days in one year

Sell RUT Nov 530/540 put spread

Sell RUT Nov 670/680 call spread

Delta of 540 put: 11.6; delta of 670 call: 16.8; total delta: 28.4

A. Using the Monte Carlo Probability Calculator (MCPC), 10,000 trials is maximum allowed.

Results: 10,000 is not that many trials. If you run this several times, you will get different results each time.

1. Delta says there's a 28.4% chance that one option will close ITM and MCPC says 29.48

2. The calls will move ITM one-third of the time; the puts move ITM one time in six. There's a greater than 50% chance that one of the options will move ITM. If you're someone who manages risk carefully, that suggests you'll be making an adjustment most of the time. And that's even more true if you adjust in stages and don't wait until one of the options has moved into the money.

If the idea of knowing you'll be forced to make an adjustment so often bothers you, then you have little choice but to sell call and put spreads that are farther OTM. Or, you can trade a stock or index that's less volatile. Either way, that means smaller premiums.

3. The probability that each of the short options will be in the money is near zero. But, if you find yourself making an adjustment on one-half of the position, I believe it pays to exit the winning side of the iron condor when it reaches a satisfactory low price.

B. Using the Hoadley calculator

1. Probability that one will end ITM: 27%. This is lower than the other calculator or delta predicted.

2. This calculator shows a higher probability of either option moving into the money: 36% vs. 33% for the calls and 18.4% vs. 17.4% for the puts.

3. There's low probability of both being ITM at one time or another, but again, the probability is a bit higher using this calculator.

Probability calculators provide information "that can be of significant value when used in a conscientiously applied program of option trading and regular risk management."

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