Lesson Overview

Probability of Profit vs. Probability of Touch

Probabilities come in many forms and today we'll discuss the differences between prob of profit and prob of touch. This becomes of the key pieces of research that suggest stop loss orders actually create more losing trades.

Probability of profit is the likelihood that a stock will not trade down/up past your strike price and stay at that level until expiration, hence the chance that you win on your premium selling strategy.

Probability of touch is the likelihood that the same stock trades down/up to your strike price at some point between now and expiration, but may not stay at that level.

More Discussion

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  • No touch does not mean it will be exercised. Most options aren’t exercised until the last week of expiration even if they are deep ITM. Touch just means that the stock price could come down/up and trade at that level.

  • Yes american options will always carry a risk of assignment which is increased as the option trades ITM vs the european style. I don’t think european only strategies are necessary. Again most options are not assigned and if they are most of that action happens the last week of expiration.

  • Yes touch and/or go thru. Yes prob of touch is nearly always double the prob of expiring.

  • They come from actual market participants buying and selling options and the volatility that’s implied through their actions.

  • Pete Allen

    I am trying to reconcile the difference between waiting until expiration versus exiting early when our profit target is reached and recycling that capital earlier. Wouldn’t it be that the probability of touch equates to the probability that we’ll reach our profit target early (to some undefined degree) and not actually go to expiration?

    • Probability of touch is the likelihood of the stock reaching the strike price anytime before expiration and touching it – in this case it would go against your position so I’m confused on how you are thinking about using it for profit taking?

      • Pete Allen

        I’m sorry, newbie misunderstanding. I was confusing strike with profit target. I am still struggling at times to keep the different numbers straight. Disregard..

      • haha no worries you had me thinking hard early just so I wasn’t confused :)

  • Rough estimate would be double the delta and times it by 100. So a delta of say .10 has a roughly 20% probability of touch.

  • Just based on implied volatility then that number taken to the appropriate distribution or standard deviation level.

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