Market-implied Probability of Profit reflects the market’s expectations of the future price of the underlying at expiration, and how volatile the underlying will be up until expiration. The accepted standard model of underlying price used in options pricing theory - like the Black-Scholes model - is the log-normal1 distribution and is characterized by two parameters: mean and width.
- The mean reflects the expected future price of the underlying security at expiration. In the distribution graph, the mean shifts the peak of the distribution graph to the left if the expected price of the underlying security is to fall, and to the right if the expected price is to rise.
- The width of the line reflects the market’s expectation of how volatile the underlying security will be until the option expires. In the distribution graph, the width of the graph widens if the market expects the future price of the underlying security to rise and fall within a wide band and narrows if it expects the future price to rise and fall within a narrow band.
You can also input your own forecasts and see the User-Defined Probability of Profit. Choose between Market Implied Probability of Profit and Probability of Profit based on your forecasts in the Filters section of the Options Wizard.
1Visit Investopedia to find out more about lognormal distribution
This article may contain links to third party websites and information, which are provided for educational purposes only. The broker does not warrant or in any way guarantee any third-party information that is provided. All links and information therein are subject to change. Probability of Profit is a mathematical expression based on accepted industry options pricing and statistical distribution models. Probability of Profit is for informational purposes only and is not a recommendation. Probability of Profit does not consider any individual investor’s financial profile, investment objectives, or other factors that would typically be used when making recommendations.
Probability of Profit does not consider any individual investor’s financial profile, investment objectives, or other factors that would typically be used when making recommendations. The Probability of Profit calculation does not include fees or commissions.
Options involve risk and are not suitable for all investors. For more information read the “Characteristics and Risks of Standardized Options” that you can find on the OCC website.