Learn more about how options delta calculations and the options probability ITM (in the money) feature can help gauge the risk in an options position.
Probability is generally defined as the likelihood of an event happening, within a certain time frame, expressed as a percentage. With options probability, the event may be the likelihood of an option being in the money (ITM) or out of the money (OTM), and the time frame might be the expiration of the option.
Armed with the right tools, probability isn’t difficult for traders to calculate. One way traders can determine probability is by looking at the options delta. Among the many pieces of information offered by options delta, many traders look at delta as an approximate percentage chance that an option will be ITM at expiration. Although it’s not a perfect science, an options delta calculation can provide a pretty close estimate.
In the Option Chain below, the underlying stock is trading around $132, so the 135-strike call is OTM, and its 0.22 delta implies it has about a 22% chance of finishing ITM at expiration. Another way of expressing this is to say the option has about a 78% chance of expiring worthless.
But there’s another way Schwab clients can estimate the chance of an option being ITM at expiration: the Probability ITM feature on the thinkorswim® trading platform. The Probability ITM can be added to the Option Chain by selecting a column header, then selecting Option Theoreticals and Greeks > Probability ITM. The calculations may be slightly different from the options delta, but the two readings are generally within a couple percentage points of each other. Either reading can be used to help define the trade’s risk. Look up and down the Option Chain at each options delta and Probability ITM and think of it as a probability analysis chart.
A quick side note: Even if an options delta or Probability ITM says 100, there’s no guarantee the option will actually finish ITM at expiration. There’s always a chance, even if it’s a small one, that the underlying stock could have a big enough move to knock something that’s deep ITM to a position where it’s OTM.
Returning to the example above, suppose that instead of just selling the 135-strike call outright, a trader decides to sell it and also buy the 137-strike call (in trader parlance, this would be “selling the 135-137 call vertical spread”). Remember, selling a single option can expose traders to potentially unlimited risk, but selling a vertical spread limits the potential loss to the difference between strikes, minus the premium collected, plus transaction costs.
According to the Option Chain above, the 135-strike call has a delta of 0.22 and the 187.5-strike call has a delta of 0.11. So, using the deltas as probabilities, there’s about a 78% chance to keep the entire credit, minus transaction costs, and about an 11% chance the loss will be the maximum amount.
Rather use the Probability ITM numbers? They’re about the same. The 135 call shows a 21.44% chance of being ITM, which means it has about an 78.56% probability of being OTM. And there’s about a 10.38% chance of the underlying rising above $137 before expiration, which again would result in maximum loss.
These numbers assume the position is held until expiration. Depending on a trader’s objectives, they could try to close or adjust this trade before expiration. But when structuring a trade and considering adjustments before expiration, understanding these probability calculations can help traders more objectively manage their risk.
Let’s look at some basics. First, if an option is currently trading at a price that’s ITM, meaning it currently has a delta greater than 0.50, it’s more likely to still be ITM at expiration. That’s basic options probability theory—the price of the underlying stock fluctuates, but those fluctuations tend to be distributed in a way that’s bunched around the current price. Picture a typical bell curve.
Similarly, an option that’s currently OTM is less likely to be ITM at expiration. And an option that’s right at the money? It’s a coin toss as to whether it’ll be ITM at expiration; a delta of about 0.50 confirms that.
Comparing an options delta (or other probability calculation) against the price at which a trader could buy or sell an option can help them determine their strategy for entering and exiting options trades.
While options trading involves unique risks and is definitely not suitable for everyone, if you believe options trading fits with your risk tolerance and overall investing strategy, TD Ameritrade can help you pursue your options trading strategies with powerful trading platforms, idea generation resources, and the support you need.
Learn more about the potential benefits and risks of trading options.
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Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Please note that the examples above do not account for transaction costs or dividends. Options orders placed online at TD Ameritrade carry a $0.65 fee per contract. Orders placed by other means will have additional transaction costs.
Probability analysis results are theoretical in nature, not guaranteed, and do not reflect any degree of certainty of an event occurring. Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options. Supporting documentation for any claims or statistical information is available upon request.
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