Best Practices

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Best Practices Around "Probability Of Touch"

Best Practices

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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Something that new option traders learn early on is that one of the things Delta can tell you is the estimated probability that the option will expire in-the-money (ITM).

For example, an option with a Delta of 16 (one standard deviation) has an approximate 16% chance of expiring ITM. This and more on Delta can be found in the Best Practices segment “Four Reasons Delta is Awesome”. Calculating the probability of touch is simple. Theoretically, it should occur twice that of the option's Delta, so that option with a 16 Delta would be "touched" 32% of the time according to theory.

The segment of Market Measures, “Probability of Touch” tested the accuracy of using delta as a proxy for an option expiring ITM and being touched prior to expiration. The theoretical values were slightly above expectations in both instances. A 16 delta option theoretically has 32% chance of expiring ITM but in reality the number was around 27%. The difference provides opportunity for premium sellers.

It's also important to recall the role that theta (time decay) plays. An option with a Delta of 35 may have a theoretical probability of being touched of 70%, but the time decay will often result in such an option still being a loser for the buyer.

Watch this segment of “Best Practices” with Tom Sosnoff and Tony Batista for the valuable takeaways and other important information related to Delta and the Probability of Touch.