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how the gears turn

Pricing Options: Probabilities

Introducing Delta and how probabilities affect option prices
XYZ is trading for $50. Which call would you expect to have the highest price?
49
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48
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47
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46
Perfect! The 46 call is deepest ITM so it will have the highest price.
XYZ is trading at $50 and you are short a 45 put. Do you want XYZ to increase or decrease in price?
Increase
Correct! Since you are short a put, you want its value to decrease. If XYZ increases in value, your put will end up farther OTM and its value will fall. Refer to an option chain for help with visualization.
Decrease
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Which options will have the most extrinsic value?
0.41 Delta
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0.52 Delta
Got it! We know this option is ATM because its delta is so close to 0.50. As you know, ATM options have the most extrinsic value.
0.67 Delta
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0.73 Delta
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XYZ is trading for $35. Which put will have the highest value?
30∆
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40∆
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$30 strike
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$40 strike
Correct! The $40 strike would be the deepest ITM and would therefore be priced the highest.
Which of these deltas could be an OTM put?
0.10
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0.45
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-0.35
You're good! All OTM options have deltas below 50, and the puts have negative deltas because they lose value as the underlying price rises. It may help to look at an option chain if you need to verify this visually.
-0.55
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If an option has a 10% chance of expiring ITM, would you expect its extrinsic value to be high or low? What about it's intrinsic value?
High Extrinsic, Low Intrinsic
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Low Extrinsic, High Intrinsic
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Zero Extrinsic, Low Intrinsic
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Low Extrinsic, Zero Intrinsic
Well done! If an option has only a 10% chance of expiring ITM, it means that it is currently far OTM. Far OTM option have low extrinsic value and zero intrinsic value.
XYZ is trading for $100. Which option has the lowest probability of expiring ITM?
115 put
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115 call
Correct! This call is the farthest OTM option and, therefore, has the lowest probability of expiring ITM.
110 put
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110 call
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Delta is used to track which of the following?
Directional Risk
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Option Velocity
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ITM Probability
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All of the Above
You are correct. Delta measures all of those things. It's so versatile!
True or False: OTM options are the cheapest because they have the highest probability of expiring with intrinsic value.
True
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False
Nailed it! While OTM options are the cheapest, they actually have the lowest probability of expiring with intrinsic value. Remember that "intrinsic value" means the option is ITM.
What is the probability a 0.30 delta call will expire OTM?
30%
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70%
Correct! This one is a bit tricky. Based on the delta, we know the call has about a 30% chance of expiring ITM. Therefore, we can deduce that its probability of expiring OTM must be 70%. (100% - 30%)
Not Enough Info
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.3%
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