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Essential Option Strategies by J. Kinahan

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Chapter 9Probabilities

Option strategies can vary from simple trades that involve just one contract to complex positions with multiple expiration and strike prices. The simple strategies of long calls and long puts were already covered in Chapters 5 through 7. Chapters 10 through 16 will cover more advanced strategies such as vertical spreads, condors, and butterflies.

You will hear a recurring theme throughout the strategy discussions. Namely, all of the strategies in Part III of this book have potential risks and rewards that can be clearly defined beforehand. In addition, every options strategy has a probability of success as well. In fact, the point that I try to drive home when I teach is that options are nothing more than giant probabilities. I determine what the probabilities are, and that helps me determine the optimal prices for buying and selling positions as well as, and perhaps more importantly, the risk I am willing to take.

But what exactly do I mean by probabilities? I discuss three distinctly different ones: the probability of expiring in the money (ITM), the probability of profit, and the probability of touching. The probability of expiring ITM is the more widely used measure, as it is the basis for most options pricing models, but you will see that the other two offer unique insights as well. Lastly, this chapter explains how to use delta as a thumbnail for computing probabilities of expiring ITM.

Probabilities are relatively straightforward when dealing with ...

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