Lesson Overview

Using Delta For Probabilities

I'm often asked, "Kirk I can't find the option probability factors?" so today I'll show you how you can use Delta as a substitute for the ITM probability alternative. This is a great way to compare apples to apples when you are using a different broker platform.

Delta will not always be as accurate as having the true statistical probabilities but it is close enough that you can make very smart decisions about which strike prices to select when creating and customizing different option strategies.

More Discussion

Was This Helpful? Add Comments/Questions

  • Renee

    Great stuff. Thx

  • Because I don’t care about a touch, what I care about is the probability of the stock actually finishing beyond my short strikes and ITM.

    • smtlaissezfaire

      I’m still a newbie at this, so maybe I’m just confused on this piece of options trading. Couldn’t the option be exercised early if it touches / goes past the strike price?

      • Could but it’s highly unlikely because if that were the case the option buyer would be giving up the “extrinsic” or “time value” left in the option contract. Most assignment/exercise happens the week of expiration.

Show Video Transcript +

In today's take-5 segment, I want to show you guys how you can use Delta as a substitute if you either don't have Thinkorswim or don’t know how to add the probability of being in the money for any particular option trade that you're looking at.

A question that we often get (and I probably get at least five emails a day on this) is, “Kirk, I don’t have Thinkorswim. I can’t figure out what the probability of my option being in the money or the probability that it’s going to lose.” In this video, I want to show you how you can use a Delta as a pretty rough substitute.

Now, it’s not going to be exact, it’s not going to be as detailed as the actual statistic, but Delta is a great tool to use, so that it gives you a good comparing apples to apples in a sense if you don’t have or can’t load the probability of being in the money.

In this example, we're going to look at Apple stock. It’s just a really good example because it’s highly traded, lots of activity in the options. And you can see that these are the December contracts and these are the January.

Whether you're in Thinkorswim or Schwab or Trade Monster or Trade King or whoever you use, interactive brokers, you’re always going to have the different contract months. Now, they will always give you the Delta of any of the options.

That’s pretty much on every broker platform. And if your broker doesn’t give you Delta, then you’d need to make a change. But Delta is the one that they usually give you because it’s one of the important Greeks.

Now in Thinkorswim, they also give us this column that says “probability ITM,” this probability that if you trade a given option, the likelihood that that option will be in the money, ITM by expiration. In this case, they have them both for the calls and the puts.

Now, let’s look at about the 120 strikes here just for Apple so that we can compare apples to apples for January and December. But in this case, the 120 strike has a probability of being in the money which is a little bit higher than where Apple is trading right now, (Apple is trading at 116.47) but the 120 strike calls for December have a probability of being in the money of 29.81.

What that means is that there's a 29.81 or basically a 30% chance that Apple trades above and closes above 120 by December expiration which is 30 days out. Now, we can then use Delta as an approximate probability because you can see the Delta of those options is .32.

You can use now Delta as an approximation because the actual probability is 30%, but the Delta is around .32. If you use Delta, you could say maybe there’s about a 32% chance that Apple trades above 120 by expiration.

If we do the same thing out in the January options, you can see that the 120s have about a 34.8% chance or about a 35% chance of trading above and closing above 120 by expiration and you can see that the Delta is a little bit higher as well out here, it’s about 38.

It’s not going to mirror up exactly, you’re not going to have a 1:1, but the Deltas (if you don’t have this probability calculation) give you a little bit better understanding of what your likelihood of success is on a given option, and it works in both directions, not only with the calls but also with the puts.

If we look at let’s say the 115 puts for January, you can see the actual probability is about 47% and the Delta is about .43. It’s a little bit off, but it gives you a good basis and context for how you can determine probability without actually having that physical calculation.

Hopefully, this video was helpful. As always, these take-5 segments are here for you guys just to take 5 minutes out of your day to learn one new cool thing about options trading. And as always, if you have any comments or questions, please leave them right below in the email and comment box. And happy trading!

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