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.
