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These probabilities play an important role in many an option trader's daily
research. Let me add a few remarks here.
As you can see from Clyde's graphs, "probability cones" actually are not
cones but parabolas. The probable price projections n days into the future
vary with the square root of n, which leads to curves of this type. So I
would prefer to call them "probability parabolas."
Option traders usually look at probability parabolas by way of some type of
spread sheet or probability calculator. The idea is to answer the
all-important question about the future pricing of an option or option
spread. For this purpose, we need to determine one important dependent
variable that goes into the above equation, and that is the future
statistical volatility of the underlying. Since we cannot look into the
future, we have to make do with an estimate.
It is, of course, entirely correct and legitimate to use the current
statistical volatility of the underlying for such an estimate, as Clyde is
doing. However, there may be a better mouse trap.
A number of scientific studies suggest that under "normal" circumstances the
best predictor of future statistical volatility is the current implied
volatility of the at-the-money options. ("Normal" meaning that the implieds
are not at extremes, such as they were after 9/11.)
The option traders in the group might want to experiment with this idea. I
certainly use it in my own trading. You will see that the probability
parabolas may then take on quite different shapes, leading to a completely
different risk assessment for your positions. If you have access to
historical option prices you can also do your own research as to the
effectiveness of implied volatilities in predicting prices.
Best wishes,
Michael Suesserott
> -----Ursprüngliche Nachricht-----
> Von: Clyde Lee(SBCY) [mailto:clydelee@xxxxxxxxxx]
> Gesendet: Saturday, March 22, 2003 17:36
> An: swingmachine-list
> Betreff: [RT] Probability Cones and QQQ
>
>
> I have shown you the price probability cones on several different
> occasions
> indicating several different ideas of their use.
>
> The attached is what cones are really all about -- option trading.
>
> Here, on expiry date we calculate a new probability cone based on the
> standard deviation of price at that time and the probability value
> we wish to use to select the strike prices for the credit spread of
> selling a call option and a put option at the strike indicated as being
> "safe" on the next expiry.
>
> This is not anything new and is well known by most option traders.
>
> This is just to give those without this exposure some idea of how
> it is possible to make relatively safe trades by selling puts and calls.
>
> Remember, NOT GUARANTEED. There is risk (as the died in the wool
> option traders will tell you) but this is an approach that will allow you
> to lower your risk and indicate to you when you should "bail out" of
> a trade.
>
> An earlier version of this software (free) is at:
>
> http://groups.yahoo.com/group/swingmachine/files/OMEGA_ELA-ELS_FOL
DER/probra
> ng.ela
>
> Much credit for getting me interested in this goes to BobR.
>
> Clyde
>
> - - - - - - - - - - - - - - - - - - - - - - - - - - - -
> Clyde Lee Chairman/CEO (Home of SwingMachine)
> SYTECH Corporation email: clydelee@xxxxxxxxxxxx
> 7910 Westglen, Suite 105 Office: (713) 783-9540
> Houston, TX 77063 Fax: (713) 783-1092
> Details at: www.theswingmachine.com
>
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