Calculating the Probability of Touch

Writing the introduction

What is Touch Probability Calculation?

The touch probability calculator provides valuable information for options traders, including the chances of any option moving in-the-money. If you hold an in-the-money option, the touch probability indicates the chance that the option will move out-of-the-money. If you hold an out-of-the-money option, the touch probability indicates the chance that the option will move in-the-money.

Touch Probability Calculator

This calculator offers useful information for all options traders, including those with substantial experience, and is referred to by more than one name. It may be called a “touch probability calculator” or a “stock price probability calculator.” Ask your broker if they have such a calculator available for use.

The fundamental question answered by this calculator is: If you plan to hold a specific option position for a certain number of days, what are the chances that the stock price will touch the strike price?

For Forex sellers: When you specify the number of days you plan to hold the short position (you do not have to hold it until the expiration date), the calculator allows you to know the probability that the underlying stock price will reach the strike price at least once during the holding period. If that probability is 15 percent, then the chances that the options will end up worthless without touching in-the-money are 85 percent.

Note: This is not the same as the probability that the option will expire worthless. Why? Sometimes, the option moves in-the-money and then moves out-of-the-money, ultimately expiring worthless. The touch probability calculator ignores those cases (in-the-money then out-of-the-money). As a good approximation, the probability of touching the stock price to the strike price (at least once before the expiration date) is double the probability of expiring worthless. Another way to express the same theory is: Any option is expected to touch the strike price before expiration by an amount equal to double the option’s delta. Note: Use delta at the time the transaction is made.

For buying Forex: When you specify the number of days you plan to hold the long position (you might exit before the expiration date), the calculator provides an approximate probability for the underlying stock price to reach the strike price (or any other price you specify) at least once during the holding period.

Other Strategies

When trading any options strategy that contains multiple legs (known as spreads), there is more than one strike price of interest. For example, in a typical butterfly spread, you own two different options.

Example:

Buy 1 XYZ October 100 Call

Sell 2 XYZ October 105 Calls

Buy 1 XYZ October 110 Call

When the stock price falls below 100 or rises above 110, the spread loses much of its value and becomes worthless if the expiration date arrives without the stock pricing between 100 and 110. Therefore, the trader needs to know the probability that the stock price will touch either 100 or 110 during the expected holding period. The touch probability calculator provides that information. Clarification: The calculator generates the probability that the stock will touch either $100 or $110. For similar strategies (like the iron condor, for instance), it is essential to know the chances that one of the different strike prices (or both prices) will be touched to manage risk effectively.

Selecting the Holding Period

Another way to use this calculator is to determine the duration of the position holding. By entering different numbers of “days” into the calculator, you can see how the probability of touching changes. By conducting the calculation every day, based on the current stock price and potential profit and loss, you can determine whether it’s worth holding the position or not.

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Article written by Mark Wolfinger, a options market maker on the Chicago Options Exchange for over two decades. He has authored several books, including “The Options Beginner’s Guide,” now in its second edition. Wolfinger holds a bachelor’s degree from Brooklyn College and a PhD in chemistry from Northwestern University.

The article was reviewed by Amilcar Chavarria, an entrepreneur in the fintech and blockchain space, with expertise in digital currencies, blockchain, fintech, investment, and personal finance.

The facts were checked by Vikki Velasquez.

Image: Caiaimage/Chris Cross / Getty Images

This was an article about calculating the probability of touch and how to use it in options trading. This calculation provides valuable information for traders and helps them make informed investment decisions. Try this calculation and benefit from it in your daily trading.

Source: https://www.thebalancemoney.com/pot-probability-of-touching-2536729