Option Volatility Analysis - the Key to 90% Winners
It is well known that most small options traders lose money. This is basically because they attempt to predict market movements in the hopes of capitalizing on a big move in one direction or the other. In the process, they are paying a premium for a decaying asset. The smart money are the traders on the other side, the ones selling that premium. They are most often "market neutral", bracketing the price movement of the underlying stock or index over a given time period. We have developed a method to calculate the probabilities of the price brackets at any time prior to options expiration for the most popular index options, the OEX, SPX, NDX and QQQQ. Here's how it works:
Below is a table of strike prices of OEX options and the probability that the OEX will close at that strike at options expiration. Probabilities are based on the current OEX price, days remaining to expiration and the OEX implied volatility.
Last Quote=574.22 on 12/28/2005.
Implied Volatility = 13.39%
Days To Expiration = 23
| Strike | Prob |
|---|---|
| 550 | 9.99% |
| 555 | 15.56% |
| 560 | 22.78% |
| 565 | 31.51% |
| 570 | 41.31% |
| 575 | 48.39% |
| 580 | 38.29% |
| 585 | 29.00% |
| 590 | 21.00% |
| 595 | 14.51% |
| 600 | 9.57% |
By knowing the probabilities of where the OEX will close at expiration, we can construct an iron condor trade for maximum profit and a defined probability of success. The iron condor is two credit spreads, a bullish put spread and a bearish call spread.
Below is an example of an iron condor trade with approximately an 80% probability of success, based on the above table. The example shows that as long as the OEX closes above 560 and below 590 at expiration on Jan 20th, our options will expire worthless and we will keep the $1,150 credit (less commissions) for a 11.5% return on investment. In this case, our margin maintenance requirement is $10,000. The OEX closed at 571.50 on Jan 20th and our trade was successful.
We can increase the probability of success (reduce our risk and potential profit) by increasing the spread between the put we sell and the call we sell. We can protect our downside risk by placing GTC contingent orders to close either spread if the OEX trades above or below our break-even points. Knowing the probabilities puts us in control of our trade, rather than being at the mercy of the market.
One of the big advantages of the Option Volatility Analysis method is that these trades can be put on at any time up until one day before expiration. The PeakInvesting site includes our successful POI strategy, covered call writing and S&P 500 Forecasting. And now with Auto-Trading, its the best options site on the web. Sign-up now for your Free Trial and receive both our Weekly and monthly POI credit spread recommendations.