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Ask Trader Guy: When Options do the Opposite of what You Want

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April 1, 2012
thinkorswim probabilities
Fredrik Broden

Q: Hey, Trader! I see probability numbers on your platform. What's the difference between the ‘probability of expiring’ and the ‘probability of touching?'

A: Here's a quick explanation without getting into all the math. The probability numbers are calculated with statistical confidence formulas that use the current stock price, the strike price of the option, time to expiration, cost of carry, and a volatility estimate. The vol estimate is the implied vol based on the current price of the option. There's a difference between the probability of expiring and the probability of touching: the expiring number considers whether the stock is above or below the strike price only at expiration. It doesn't consider where the stock has been between now and expiration. The probability of touching considers the possibility of the stock hitting that strike price anytime between now and expiration.

Q: Hey, Trader! I bought an out-of-the-money call on a stock, thinking the stock would go higher. Well, the stock went up, but my call lost value. What happened?

A: Option prices are affected by several factors, one of which is the price of the stock. But time passing and changes in volatility can have a big impact, too. If volatility dropped as the stock went up, and time went by (as it always does), then the negative impact on the option price due to those factors could have exceeded the positive impact of the price increase of the stock. If the stock doesn't move high enough, fast enough, then a drop in volatility and time passing can turn a long call position into a loser.

Q: Hey, Trader! People are talking about the relationship of the dollar to oil. How does that work?

A: Oil is one of the few dollar-denominated commodities in the world. No matter where you are, oil is quoted in US dollars. Now, let's say you're a Russian oil producer that hopes to make a certain amount of rubles from a barrel of oil. You need to convert into rubles the dollars you receive from selling that oil. If the US dollar rises relative to the ruble, you could convert those dollars into more rubles. Therefore, you're willing to sell oil at a lower price when the US dollar is higher, because the high dollar lets you turn the lower oil price into the same number of rubles. The opposite is true if the dollar is weak. You'd need to sell your oil for a higher price in US dollars to make the same number of rubles.

Q: Hey Trader! My New Year's resolution was to lose weight, but the missus set me up with a trainer who can only meet me near the close of trading. What should I do?

A: Being able to see your knees is highly overrated. Rest your troubled mind. Trade right up to the close, and have another burrito.

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