Hello, traders, I'm Mike Obucina, senior content
producer here at TD Ameritrade.
And in this video, we're going to walk
through how to do probability analysis on the Thinkorswim
desktop trading platform.
Specifically, we're going to look
at the probability analysis tool, which
is found under the Analyze tab.
Now to start the video, we're just
going to kind of walk through the tool, how it's laid out,
where everything is located.
And then show you some examples and how you
can do probability analysis.
We're going to start simple and work
our way to a more advanced example
by the end of the video.
So let's jump in to get started.
To get started using the probability analysis tool,
let's navigate to the Analyze tab and then the probability
analysis subtab.
We'll put an assemble and for this example, let's use Apple.
Now as you see as we did that, the probability analysis chart
has been activated.
Below that, we have a table of information .
And then below that two sections,
one called Price Slices and the other Positions
and Simulated Trades.
We're going to focus on all these areas here in a second,
but let's just close this up for now.
I want to focus on the probability analysis chart.
Now you can see we have some elements on the chart.
We have the implied volatility of Apple listed here
in the upper left hand corner.
The y-axis represents the price of the underlying,
in this case, Apple.
And then the x-axis represents days on to the future,
so 10 days, 20 days, 30 days, and so on.
You'll notice that as I move my mouse
throughout the probability analysis chart,
a pair of cross hairs will follow my mouse
and you'll see two numbers listed-- a percentage above
and a percentage below.
Essentially, what this represents
is a probability of Apple moving above or below a certain price
by a certain date and time.
You can turn these off by clicking this target button
here at the top of our menu.
I'm going to leave that turned off for now, because I want
to discuss some of the data that we're seeing on this analysis
chart.
The first thing I want to focus on are the vertical dash lines.
These are the options expirations for Apple.
Now the prices you see horizontally listed here,
We Have one line here dead center of our chart
then we have one above, one below.
These are our price slices.
So if we look down here on our page,
we have first, the middle price.
This is the current price of Apple.
And because the padlock is open, this price
will float automatically as the market moves up and down.
Now the two levels above and below by default
will represent a 10% price level above the current price
and a 10% price level below the current price.
These padlocks are also open, so as the price moves up and down,
that 10% value will move up and down with it.
Now what about this probability analysis graph?
Well, very simply put, this is the one standard deviation
move of Apple, up or down, at any given options expiration
date.
So you can see up here, we have this probability range
of 68.27%.
That is set to a one standard deviation move.
Now these prices are being calculated off
of the implied volatility of Apple and the options pricing
model.
OK, so how do we actually start using
this to analyze scenarios and analyze probabilities?
Well, we're going to start with a few different examples
and we're going to start simple, kind of work
our way into a more advanced example later in the video.
But first, let's start with a basic stock trading example.
Let's imagine you were thinking of buying shares of Apple,
but you only want to buy it if it gets down to $300.
Well, let's cue up that order, and that
would be a limit order, and it would be below the market,
so I'm going to type in 300.
So now you have to ask yourself--
what is the probability of Apple trading back
to 300 anytime soon?
Well, if we go to our Analyze tab and probability analysis,
and we find that $300 price level,
we can do this one of two ways.
We can use our mouse or we could just set a price slice of $300.
I'm going to do that on my lower price slice.
As I type that in, you can see that this padlock
is now locked, meaning it won't float with the current market.
It will stay at that level.
And now if we find that $300 price level,
you can see at any given point as we move our mouse out
in time, those percentages will start
telling us what's the probability of getting
to or below 300.
Well, in this case, the odds aren't looking great.
You can see we have roughly, we'll call it,
a 2% chance of Apple getting to that price level anytime soon.
Now as time goes out, you can see our odds increase.
Now this is where we can also use this table,
you can see the odds of Apple getting below 300, which
would fill our limit order, as we go on
and the option expiration dates, you
can see that that percentage increases,
but we really don't have a great chance
of getting filled at 300 anytime soon,
even if we go out to December.
OK, for our next example, let's take a look
at a scenario of buying a long call.
What's the probability of being successful on a long call
purchase on Apple?
Well, the first thing we do is we're
going to go to the Trade tab.
Let's take a look at the July options, which
have 42 days left, I'm going to click that open.
And let's imagine we thought at had a chance to keep going up
and we were thinking about buying
let's just say the 345 call.
Right now, it's trading for 485, call it $5, roughly.
What's our probability of being successful on this trade?
Well, there are ways on the option chain
to assess your probabilities.
And real quick, let's pop those in.
I'm going to change these to columns.
The first one, I'm going to change last price
to probability of ITM or in the money.
And I'm going to change this column
to probability OTM or probability of out
of the money.
Now what are these numbers telling us?
Well, if we look at our 345 strike
and we go over the probability of in the money,
because we're thinking about owning this call,
we want it to be in the money by expiration,
which would mean Apple would need to be trading
one penny higher than 345.
So 345 and one penny, what's the probability
of trading at that level or higher
by expiration in 42 days?
Well, the options are telling us that it's only about a 27,
28% chance of that happening.
So you can see just off the bat, getting to and staying
above our strike by expiration, we only
have about a 27% chance of that happening.
However, remember, if you're purchasing a long call,
you actually have to factor in what
you pay for the option, which is your break even point.
So we would take 345 and we would add this $4.80 option
price, which means our break even is actually $349.80.
Now you can see we don't have that price level here
on the option chain, so we can go over to the probability
analysis tool--
and remember, we were looking at the July 17 options--
and we want to know what's the probability of Apple getting
above $349.80, which would be our break even point,
where we even start to make money on this option
at expiration.
There's that expiration here on our chart.
And we're going to go up to the $349.80 price level.
So there you see we have roughly only
a 25% chance of breaking even on this trade by expiration.
Now if you're comfortable with those odds
and you're willing to take the risk of paying the option
premium to have a one in four chance of making money
on the trade, then that would be your decision.
However, you would have a 75% chance of not
succeeding in this trade.
OK, for our next example, let's show you
how to sell a vertical call spread
and analyze the probabilities on it
using the analysis chart and the data associated with it.
So when I go to the Trade tab and we'll
use the same July expiration that we did on the long call
example.
Now remember, as we were looking at this 345 strike--
I'm just going to highlight that real quick--
you can see we assessed that there was roughly a one
in four chance of this option being in the money
by expiration, which if we think about it logically
says, that there's a three and four chance
that this option will be out of the money by expiration.
And if you're the seller of an option, those are good odds.
70%, seven in 10 chance--
those are good theoretical probabilities.
So maybe we want to sell that 345 call instead of buying it.
Now a naked short call has unlimited risk, so let's
define that risk by buying the 350 call
and turning this in to a short vertical spread.
Now our bias on this trade is that we are bearish.
We are hoping that Apple stays below 345
by July expiration in 42 days.
And in doing so, and we'll just lock that in at 140,
we'd be collecting $1.40 to sell the spread.
The max risk on this trade would be the five point widespread
minus the credit.
So basically, our risk would be $3.60 to be making $1.40.
So one, what's our probability of being successful,
and two, what's our probability of at least breaking even
on this trade?
Well, we're going to do the same analysis
we did with the long call.
First, you can see the 345 call here
tells us exactly the probability of Apple trading at 345
or lower is roughly 72%.
Now those are pretty good odds.
Now what's the break even on a trade like this?
Well, if you know your options, you would take your short call,
which is the 345 call, and we would add the $1.40 that
we're collecting for a break even of 346.40.
Now you can see we don't have that 346.40 price listed
on our option chain, so we have to go over to the Analyze tab.
And now, same thing we did before-- we're
going to go to that July 17 expiration.
Let's find our break even point of 346.40,
and we'll be as close as we can to that price level.
And there you see we have roughly a 70% chance of Apple
staying below our break even, and a 30% chance of breaching
it and trading above.
Now one other thing I want to show you
is the Positions and Simulated Trades section.
In this area, we can actually put in an existing position
or a simulated position, maybe something
you're thinking of putting on, and we
can analyze the probabilities of being successful or not based
on different factors.
And we can tweak those factors to create different scenarios
and then see how the probabilities change
based on those factors.
So let me show you what I'm talking about.
The first thing I'm going to do is
I'm going to go to my Monitor tab.
And in this practice paper money account, I have some positions,
but let's look at this Exxon Mobil position,
because we are short one put.
We're short of June 43 put, which
has 17 days left of trading.
We sold the put for $1.05.
It's currently trading for $0.40,
so we've made some money on this put.
And we can see because the stock price is trading well
above our short put price-- right now,
the stock's at 47.47, and we're short the 43 put,
so this option is out of the money.
It's lost value, and because we sold the option,
we are profitable at this moment.
But what can happen?
Well, price could go down, volatility could go up.
And as time goes by, theta is going to decay,
and this option is going to lose value based on time.
So there's different variables that
are going to affect the price of our option.
And with that, the probabilities of this option being in or out
of the money will also differ.
So let's take a look at our Analyze probability analysis
tool.
And this time, I'm going to put an XOM into the symbol look up.
And you'll notice because we have position in XOM,
this field below position in simulated trades
is populated with some data.
Now if you see both items checkmarked,
may be at multiple positions, make
sure you only checkmark the option
or position that you want to analyze.
So in this case, we have our June 43 put,
which we traded for $1.05..
Now let's just look at the probability analysis graph
as if nothing were to change at this moment.
We just want to know right now at this point in time what's
our probability of keeping the premium that we
sold on this position.
And the first thing I'm going to do
is I'm going to change the probability mode.
And you see there's three different probability
modes-- in the money, out of the money, and touching.
Really quick, what's the difference?
Well, probability of in the money--
if you notice when I hover my mouse-- once again,
there's a number above and below our crosshairs--
that number above is going to be the probability of a call
option being in the money.
And the number below is going to be the probability of a put
option being in the money.
And when we hover over that $43 price level, which
is our short put, and we go out to our June expiration,
you can see that we are essentially right, actually,
near that probability distribution curve.
But to be more specific, there you go,
we have roughly a 17.53% chance of this option being
in the money.
Now if we were the owner of this put,
that number would be valuable to us,
but because we are the seller of this put,
we want to know the odds of this thing being out of the money
by expiration.
So when we switched from probability ITM to OTM,
you'll see those numbers inverse.
So when I go to that 43 price level on our expiration date,
you will see that we will actually
have that 81% probability of keeping this premium,
because once again, we sold the option.
And we want this to go out worthless
and be out of the money.
So by changing the probability mode to OTM,
we can then see, all right, that lower number is telling us
that we have roughly an 80% chance that this option will
remain out of the money.
Now what other type of analysis can we do with this section?
Well, if we go back down, you can see right here,
we can adjust date.
So that means let's just assume stock price doesn't move,
volatility doesn't increase or decrease, but time goes by.
And we're going to go ahead-- let's
just move ahead 1, 2, 3, 4, 5, 6,
7 days-- we're going to go ahead one week in time.
Now let's go back to the probability analysis graph.
And you can see our June 19 expiration
has moved closer to that zero day
because we've advanced time.
And we're going to go to June 19 and we're going
to find that $43 price level.
And you can see our probabilities have increased
about 10% that this option will remain out of the money
just if time advances, everything else staying
the same.
Now let's make some more adjustments.
We can click this gear wheel.
And you can see now we have two new fields-- volatility
adjustment and stock price.
Well, let's say Exxon sells off $3 in the next week.
Time has gone by, and we've lost $3.
Let's say it goes down to $45.
Well, that's not going to be good for our position,
because now our short strike is starting to get threatened
and we're still not at expiration.
So if we go to our options graph or a probability graph,
and we put our mouse on the expiration and find $43,
you can see now we have roughly a 68, 70% chance of this option
being out of the money.
Still, the odds are in our favor,
but now we're well within the standard deviation distribution
curve.
And that's because price is reduced
and now our short strike is getting
close to being threatened.
Now finally, what have volatility changed?
Because you would expect that if price dropped like that so
dramatically in a short period, you
would see that maybe volatility will increase.
And as the seller of an option, that's not good for you.
So what if we made this increase of 3% in implied volatility?
Now, let's go back to our graph one more time,
and I want to put my mouse on the line and find $43.
And now you see where I've gone even further
inside that distribution curve.
And now we're talking about a 69, 70% chance of that option
remaining out of the money.
So not a huge difference, but you
can see as volatility increases, we
would then be worried that the price of our option
is increasing as well.
And finally, if you just want to reset everything get back
to your default settings, you can click this Action menu
in the upper right hand corner, make sure it's the top one.
And you're going to hit Reset.
This will ask if you want to reset the system to default
and any unsaved adjustments will be lost.
You hit yes.
And now everything will go back in terms
of your date, your volatility, your stock price, as well as
your price slices.
And that's a quick look at the probability analysis
tool in the Thinkorswim desktop trading platform.
Now remember-- probabilities and probability analysis
is theoretical in nature, which means
the outcomes of those probabilities
are not guaranteed and do not reflect
any certainty of an event occurring in the future.
So keep that in mind.
Now remember, if you're looking for more in-depth walkthrough
and tutorials on the Thinkorswim desktop trading platform,
head over to the Thinkorswim at tlc.thinkorswim.com.
And for more great content and investor education,
check out all the videos on our YouTube channel.
Subscribe and get notified when we released new content.
So thanks again for watching the video and happy trading.