|  DEC 1997

Time and Options Probabilities by John A. Sarkett

For traders who want to use options to hedge their long positions, here are the formulas for calculating the prob-abilities. What’s the probability that Intel [INTC] will be above 110 at a certain point? Three months from now, six months, a year? If you were to ask random-walk partisans, they would be likely to tell you, “There’s no way to know.” You would get the same answer from those who disparage market timers. But change the time frame to a more manageable short-term window — say, the week or two before the very next options expiration — and a little-known formula would be able to give you the exact mathematical probability. Time is the key. Filter with technical indicators such as trend, moving average, oscillators and your own judgment, and you can use the estimated probability to your advantage by selling out-of-the-moneyÝ option premiums. Typically, the odds will favor your sale about 66% of the time, leaving just a 33% possibility that the buyer on the other side will actually call away your stock. Lending further credence to this strategy, economists at the Options Clearing Corp. report that, on average, 67% of all options expire at zero or at a loss.

by John A. Sarkett