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Aristotle said, “The probable is what usually happens.”
The great philosopher understood early on that we can use mathematical probability to determine how likely it is something will, or won’t happen.
Probability is basically common sense reduced to calculation. And it can’t be escaped.
We use it in so many aspects of our lives. Probabilities have become a tool of fundamental importance to nearly all scientists, engineers, medical practitioners and industrialists.
When your team has a coin toss before the game, you have a 50/50 chance of winning it: either heads or tails. A basketball player steps up to the free throw line and has a good idea, based on past performance, whether he’ll make the shot. A football team tries for a field goal when they think the distance to the goal is close enough that they’ll likely make it.
More importantly, if you are told you need surgery, you’ll want to know the success rate of the operation. Based upon the statistics, you can make an informed decision whether or not it’s a good choice for you. You might decide whether or not to begin a course of medication, based on other patients’ positive outcomes or side effects.
These are just a few more examples of how probability plays a part in our lives.
How to Start Investing Successfully
Unfortunately, when it comes to the market, many investors don’t use common sense and ignore the probable. They quickly fall prey to highly unlikely, get-rich-quick schemes.
It happens every day in the market.
Let me explain using an options chain of the Russell 2000 ETF (IWM).
IWM is trading for $116.67. So, any strike 117 or higher is considered out-of-the-money (shaded gray).
The column on the far left labelled Prob. ITM states the chance IWM closes at or above a specific strike at July expiration in 38 days. As IWM moves incrementally higher from 117 to as high as 129 the percentages decline. It makes sense, right? With only 38 days left until expiration there is a greater chance of IWM reaching 117 than 129.
But the most insightful part of all this is when we begin to look at the percentages. If you look at the second column, Open Interest, you can see that more options contracts (51,981) have been traded at the 120 strike. Yet, the percentage of IWM closing above the 120 strike at expiration is only 26.28%.
This is where common sense takes a turn for the worse…at least for the speculators.
Speculators are willing to take a 26% chance that IWM will close above 120 at options expiration in July. Fortunately for us, we are able to sell them the July 120 calls for $0.82, with a probability of success of 74% (100-26).
Moreover, we have the ability to increase our probability of success even further by choosing to sell speculators a strike further out-of-the-money.
For instance, we could sell them the July 121 strike for $0.57 with roughly an 80% probability of success or the 122 strike for $0.38 with approximately an 85% probability of success.
It is just common sense investing. We are simply using probabilities to our advantage. Yes, the terminology might be different than what you are accustomed to, but with a little hard work you can quickly overcome the basics for the opportunity to reliably bring in safe, consistent profits.
This Thursday I will be discussing in my free, live monthly webinar how to use probabilities for safe, steady income. If you are an income investor or simply want to explore alternative ways to invest, you don’t want to miss this one. Click here to register.
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