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Pricing Options: Probabilities
Introducing Delta and how probabilities affect option prices
Dancing Deltas
It is important to realize that deltas are not static. They change with respect to underlying price, time until expiration, and volatility. This means that the option velocities and probabilities will change along with them.
What This Means for Traders
The shifting of probabilities can be a tough reality to accept even though you KNOW it will happen. It's easy to allow your ego to think that a position with a 70% probability of profit (POP) will retain those odds throughout the life of the position. The reality is those odds can easily shift to 50%, 30%, all the way down to 0%. This is the nature of the business and can be frustrating at times. On the bright side, it can also benefit us in the same way. There will be times when you have a sure loser that suddenly becomes a strong winner. Our success as traders will greatly depend on our ability to acknowledge the reality of our odds and adjust as necessary to keep them favorable.
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