It Took Us 15,000 Trades To Find Our Preferred Delta

Summary

This video explores the concept of 'probability of touch' in options trading, focusing on how early management, particularly at 21 days to expiration, significantly reduces the risk of options touching their strike price. The script compares theoretical versus realized probabilities of touch across various Deltas (10-45), showing how managing options early, especially for out-of-the-money options, improves trading outcomes. Key insights include the reduced probability of touching for both calls and puts when managed early, and how managing positions can flatten out P&L curves, making it a vital strategy for successful options trading.

Takeaways

• 😀 Probability of a touch refers to the chance that an option touches its strike price before expiration. It is roughly 2 times the Delta of the option.
• 😀 In bull markets, calls are more likely to touch the strike price than puts, though the realized probabilities of touching strikes are much lower than theoretical probabilities.
• 😀 For options with a 20 Delta, the theoretical probability of a touch is 40%, but the realized probability (with early management) is much lower, around 10-14%.
• 😀 The ratio of realized probability of a touch to the theoretical probability decreases when positions are managed early, showing that the actual chances are significantly lower than expected.
• 😀 Analyzing short option strategies, managing positions early (at 21 days) significantly reduces the probability of a touch compared to holding them to expiration.
• 😀 Focusing on the 20 Delta doesn't necessarily provide the full picture—options with varying Deltas (10 to 45) exhibit different outcomes for probability of a touch.
• 😀 Exit strategies for options with a 21-day horizon lead to better results, especially when compared to theoretical expectations, across a range of Deltas.
• 😀 The gap between the theoretical and realized probability of a touch narrows as the Delta increases, indicating a higher risk for larger Delta options.
• 😀 For out-of-the-money options (Deltas 10-25), the probability of a touch is lower than theoretical expectations when positions are managed early, making them more effective.
• 😀 The difference in probability of a touch between puts and calls narrows when positions are managed early, with puts typically having a slightly lower realized probability.
• 😀 Early management of positions (especially at 21 days) is crucial to reduce the probability of touching the strike, preventing unexpected outcomes and flattening the P&L curve.

Q & A

What is the probability of touch in options trading?

The probability of touch refers to the likelihood that an option's strike price will be reached before expiration. It is typically calculated as two times the option's Delta, providing a rough estimate of the chance that the option will touch the strike price.

How is the probability of touch calculated using Delta?

The probability of touch is calculated by multiplying the option's Delta by 2. For instance, if an option has a Delta of 20, the theoretical probability of touching the strike price is 40% (2 * 20 = 40).

Why is the realized probability of touch lower than the theoretical probability?

The realized probability of touch is often lower than the theoretical probability because the market conditions and the early management of positions (such as exiting before expiration) reduce the chances of touching the strike price.

What is the impact of managing positions early on the probability of touch?

Managing positions early, typically around 21 days before expiration, significantly reduces the probability of a touch. This early exit strategy helps decrease the likelihood of the option's strike price being touched, lowering the risk compared to holding the position until expiration.

How does the realized probability of touch differ across various Delta values?

For lower Delta options (such as 10-25), the realized probability of touch is significantly lower than the theoretical value. Higher Delta options (e.g., 40-50) have a realized probability that more closely aligns with the theoretical value, indicating a higher risk of touch.

What role does Delta play in the probability of touch?

Delta represents the option's sensitivity to price changes in the underlying asset. A higher Delta means a higher probability of the option reaching its strike price, both in theory and in reality. However, the realized probability of touch is often lower for lower Delta options, especially when positions are managed early.

What was the primary finding regarding the call and put options in the study?

The study found that in a bull market, call options have a higher probability of being touched compared to put options. However, when positions are managed early, the difference between calls and puts becomes marginal, and the probability of touch decreases significantly.

What happens to the probability of touch when positions are exited at 21 days to expiration?

When positions are exited around 21 days to expiration, the realized probability of touch significantly improves, meaning it is much lower than the theoretical probability. This early exit strategy proves to be particularly effective in reducing risk, especially for out-of-the-money options.

Why are the results for out-of-the-money options more significant than for at-the-money options?

The results for out-of-the-money options are more significant because the theoretical probabilities of touch for these options are much higher. However, the realized probabilities are much lower when positions are managed early, which indicates that managing these positions early can effectively reduce risk and improve performance.

What is the key takeaway from this study on options management?

The key takeaway is that managing options positions early, around 21 days before expiration, can significantly reduce the probability of touch, particularly for out-of-the-money options. This strategy helps to minimize risk and improve the effectiveness of short options strategies.