101Option Trading Secrets Section 5 pptx

Section 5 Option Analysis [...]... that the stock price had a lot of resistance at 65 With the stock at 57 , the Oct 65 call was 80 ($80) with only three weeks until expiration Setting a stop-loss at 66, I ran a simulation of the probability of hitting the stop-loss The simulator indicated only a 5% chance of hitting the stop-loss, and that is how it worked out The play was to write the Oct 65 call naked, and the option expired with the... determine the probability of hitting a profit goal or stop-loss price based on the underlying security or futures For example, if you planned to buy the January O P T I O N A N A LY S I S Pfizer 45 call on October 15, when the stock is 41, what are the odds of hitting 47 by expiration? A simulator and probability calculator would tell you However, a simulator can also tell you the probability of hitting... example, if the delta is 5, the option will move half a point if the underlying instrument moves 1 point The delta is a O P T I O N A N A LY S I S good way to compare one option play to another; the higher the delta, the better the play for the option buyer; the lower the delta, the better the play for the option writer The delta is an excellent option analysis tool Use it! 170 Secret 59 USE PROBABILITY... Stock Price is at 63: 0 Profit or Loss × 40 % 0 183 O P T I O N A N A LY S I S When IBM Stock Price is at 65: $200 Profit × 20 % $40 When IBM Stock Price is at 70: $700 Profit × 10 % $70 Now let’s add up all the results of these multiplications: – 90 IBM at 60 or lower 0 IBM at 63 + 40 IBM at 65 + 70 IBM at 70 + $20 Profit or Loss (Expected Value) The result of this multiplication and addition... and a simulator, you can get much more concrete numbers to carry out this analysis Altogether, the mysteries of Baysian Analysis have, I hope, been unraveled, and you can find its magic helpful 1 85 Secret 65 GONE IN 60 MINUTES How do you select options analysis software? When it comes to selecting options analysis software, you truly can get lost in the trees Many programs on option analysis overkill... spreads that are designed to be held till expiration Option buyers may be surprised at the results of the proba- O P T I O N A N A LY S I S bility calculator, for your probability will never be greater than 50 % in a random market and usually lower than most would think The point that should be made here is that we are assuming the position is held till expiration However, these low probability results demonstrate... Historical volatilities are available on the web in a variety of locations, such as ivolatility.com Once you have a good historical volatility, it is easy to measure the fair value of an option 164 Secret 57 IMPLIED VOLATILITY— AN OPTION ANALYSIS SHORTCUT Implied volatility is the volatility built into the option price It is what the market thinks the volatility should be A computer program can measure... followed by looking at a chart of the historical volatility over the past months or years Also, implied volatility can be used when calculating a probability of profit or or when using a simulator 167 Secret 58 KEEP YOUR EYES ON THE DELTA The delta is one of the Greeks (ratios) generated by pricing programs The other Greeks are the gamma, theta, and vega I rarely use the other Greeks, although they are used... ongoing analysis of the IBM fundamentals and plenty of homework on the other aspects of the market, we decide there is a 10% chance that IBM will be at 70 at the end of July, a 20% chance it will be at 65, a 40% chance it will be at 63, and a 30% chance that IBM will not be above 60 when the call option expires How did we come up with these probabilities? In a sense they were taken out of the air Hopefully... our strategy? Let’s add one more feature in mapping out this strategy The profit or loss at each price level of the stock is as follows: IBM Stock Price When Option Expires Probability Profit or Loss 70 65 63 Below 60 10% 20% 40% 30% +$700 +$200 0 (-$300) Note: Commissions not included Now we are ready to gaze into the crystal ball and find what the future holds To do this, we will refer to the Baysian . Section 5 Option Analysis