Platinum scans allow you to search and sort trade results by a variety of different settings, including Probability of Touch, which is a variation of the % to Double search. This ranker uses historic price movement and the % to Double price level to provide expectations for those levels to be reached by expiration. A Probability of Touch using breakeven levels or user-defined inputs can be accessed via the Probability Calculator.

A Straddle Scan was performed on S&P 100® Index optionable stocks near the close of trading on Monday, June 1st. Trades were searched using the Highest Probability of Touch 20-90 days setting. This was selected to maximize the potential for success given the high premium costs for straddles. Although volatility is currently high from a historic perspective, it has significantly declined over the last few months.

The scan was completed as part of a Weekly Outlook performed for System Trader subscribers. It considered potential trades for a relatively strong sector - energy - for views that ranged from more neutral (straddle), to slightly bullish (strangle), to bullish (long call). The fourth ranked trade was an Aug 60 straddle for Schlumberger (SLB), an oil well services and equipment industry component of the energy sector. The Probability of Touch was low at 8.57%, but this value reflects the probability of doubling the position value, a pretty lofty straddle goal.

Using the scan as a basis for further analysis, the following three trades were reviewed:

Table 1: Trade Statistics for Probability of Touch Calculation

When considering the first two trades:

The higher cost for the straddle versus the strangle results in a higher Upside Breakeven and lower Probability of Touch when considering a move to the upside.

The put's lower strike price for the strangle versus the straddle results in a lower Downside Breakeven and lower Probability of Touch when considering a move to the downside.

A trader more bullish on SLB may opt for the lower risk strangle that has a higher Probability of Touch on an upside move. This is not the point where an analysis should end though. If SLB closes on expiration Friday at either strike price, the position will be worthless. Trader's can revise the Probability Calculator inputs to better reflect position constraints.

The Probability Calculator is accessible via the probability table that appears with Risk Graph I or Risk Graph II display. The second column (Probability of Profit) includes a link to the calculator at the 0 days to left to expiration value.

Figure 1 provides the Probability Calculator's default input assumptions for the SLB Aug 60 straddle. The breakeven levels (price targets) and probability for touching these targets are emphasized with darker boxes.

 

Figure 1: Probability Calculator Results with Default Settings

Since all three positions are comprised of long options, a trader must consider the probability these different price targets will be met closer to 39 days before expiration rather than at expiration (81 days). When the time allocated for price movement is cut in half, the probability SLB will reach the different targets declines significantly (summary results provided in Table 2).

This brings us back to the original reason for selecting SLB; it is in a relatively strong sector with a confirmed bullish chart. Figure 2 provides a weekly view of SLB with a short-term and intermediate-term bullish trend objectively defined with upward trending 4-week and 10-week exponential moving averages [EMAs]. The longer-term, 40-week EMA is neutral.

 

Figure 2: Weekly Chart for SLB with EMAs and channel Support/Resistance

The weekly chart for SLB also includes three horizontal lines reflecting support/resistance areas. Prior to the extreme roller coaster ride SLB experienced, it spent months traveling between support at 57.23 and resistance at 68.22, an area where it recently returned (top two lines). An upper target that represents 80% of the channel move is displayed on the chart at $66.48.

The lowest horizontal line is drawn at last week's price low for SLB. The original analysis included a potential stop at the 10-week EMA; however since moving averages move, they can continue downward past a reasonable risk point for you. For this reason, the weekly price low at 50.64 was also included as a potential stop.

Any of these can be used at price target inputs using the calculator. As an alternative approach, a regression line was drawn using the last 22 trading days to create the center regression line. This is likely the most objective techniques used in this article because the slope of the channel line will vary greatly depending upon the start date used. Since we're looking 42 days forward, it's more objective to create the channel going back 42 days. This captures a strong uptrend and results in a channel that provides an expected price (mean, or center line) on July 13th that is pretty high (69.35). Just going back an additional four days to include the upward gap on 6/24/09 increased the mean value to 64.45 versus 60.74.

 

Figure 3: Daily Chart for SLB with Regression Channel and Future Price Points

Revising the Probability Calculator inputs to reflect 42 days, and 42-days with a mean value of 60.74, the last two columns for Probability of Touch% were obtained (Table 2). The inputs sued for the last column are displayed in Figure 4. Note the Rate of Return reflected on the calculator given 60.74 as the Stock Mean at Future Date value.

Table 2: Summary for Different Probability of Touch Percentages

 

Figure 4: Probability Calculator Inputs for 42-Days and 60.74 Mean Value

Although the single call position has the greatest probability of touch for all scenarios, it has greater directional risk since it will only increase in value with rising SLB values. As always, it's for the trader to determine their outlook for future price behavior, whether a trade represents reasonable probabilities for their style, and whether a particular trade fits their risk parameters.

To access other articles written by Clare White, please click here.

Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site

Questions for Clare? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

• Email This Article
• View Full HTML
• Digg This
• Delicious
• Subscribe

Recent Articles by Clare White, CMT, Optionetics.com

• November 19, 2009
  Analytical Toolbox: Hedging in a Bull Market
• October 30, 2009
  Analytical Toolbox: QQQQ Current Market Conditions
• October 22, 2009
  Analytical Toolbox: Assessing Risk Given Two Expiration Months
• October 15, 2009
  Analytical Toolbox: Modidor Update
• October 8, 2009
  Analytical Toolbox: Modidor Channel