Home » What is probability and how it works in Stock Market?

What is probability and how it works in Stock Market?

Probability theory:

A field of mathematics concerned with the examination of random processes is known as probability theory. A random event’s outcome cannot be predicted before it occurs, although it could be any of multiple possibilities. The final result is said to be dictated by chance.

Now how does that apply to stock market?

A Stock/index has three probibilities that is

  1. it can go up that is increase
  2. it can go down that is decrease
  3. it can remain around same price

So, there is 33.33% probability of a event above happening.

Now, how does this apply to stock/index options?

Call option and put option have 33.33% of success, so that is very clear to anyone.

Stock remaining around same price within expiry has 33.33% probabiliy. Option selling needs the stock/index to reamin within a range closer to option strike price with a cushion of time decay as time is nearing expiry and premium payment on either side as cushion. The time decay and premium payment makes option selling more probable to occur.

What is probability of Profit (POP)?

If a transaction is entered with a 72 percent likelihood of profit, we can expect the trade to be profitable 7 out of 10 times that is P.O.P. is statistically significant.

Trending, non-Trending/Range bound market?

It is said to be that market or stock or index stays anything around 70-80% range bound and trend only 20-30% which makes odd easy for option sellers making money most of the time. But when they loose if no risk/reward is maintained or no stop loss maintained then could loose huge money or losses.

What favours odds for Option sellers?

The stock/index remains near the same price 33.33% and going oposite to bet side that if sold Call option price going down or if sold put option price going up is 33.33%. So that is total of 66.66% probability of options sellers comparing a naked option buyer with only 33.33% probability.

Simpliest way to trade with options with limited profits and risk?

Answer is Vertical spreads, having a defined risk and defined reward makes the vertical spreads ideal in options strategy. But need to look for splipages if options is not liquid enough. Here the risk and reward can be defined before starting the trade with a pay-off graph.

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