Expected Value
[Update: We've added more Expected Value calculations using Monte Carlo analysis. You can read more in our blog.]

Expected value is a statistical measure that tries to predict the strategy's value, assuming you could have executed it many times at different dates but with the same prices/distances, etc. It is calculated by summing the payout at expiration multiplied by the probability of that payout.

In simplified terms: The Expected value is the 'edge' of the strategy, assuming current option pricing.

How to calculate it: 

We use 2 calculations for the Expected Value. In the scanner, we use the options prices to calculate the EV. In the scenario engine we use Monte Carlo analysis. Check our blog for more information. Here: Calculating Options Expected Value using Monte Carlo Analysis.

Calculating EV using options prices:
The above picture is an example of a bull spread. To calculate it, we sum the payout and probability of the three sections:
  • The profit of Range 1 * probability of being in range 1 (above the higher strike)
  • [Minus] The loss of Range 2 * probability of being in range 2 (below the lower strike)
  • [plus] The profit/loss of range 3 * probability of being in range 3 (between the two strikes)
Summing these three ranges will give us the expected value of the strategy.

Why use Expected Value: 

When looking at the options chain, we can usually choose strikes that are closer to the money and pay more (higher profit/ loss) and have a higher probability of them to be in the money at expiration (higher chance of profit/loss), or go further in the chain and have a lower likelihood of them being in the money (which is profit if you are selling), but cost less. These two parameters: profit and probability of profit, are in a reverse relationship: the higher the profit, the lower the probability (and vise versa).
Expected value considers this and helps you find the OPTIMAL strikes and expirations for your strategy.

When a strategy has a higher EV it means that it has the most significant edge, using current options pricing..

How to use Expected value: 
EV is very useful, and we are using it in many saved scans and predefined scans. Here are some ways you can use it in your trading:

  1. Filter trades based on EV - For example: if a strategy doesn't have a positive EV (meaning has an option-pricing edge), filter it out of the results.
  2. Sort trades according to EV - Once you entered the parameters you want, sorting by EV will allow you to analyze trades according to the most significant edge and go from there. That way, you save time on your analysis.
  3. Find the optimal spread/Iron condor on a stock you want - you can use the included symbol to look for a specific stock/watchlist and then sort by EV and click the expand button. It will show you all the different spreads you can do and help you find the optimal one.
  4. Measure the edge in different trade - add the EV column and set it on ANY to see the EV as a measure of edge for the trade you want to take.

Read more:

  • Read about EV and Iron condor in our blog
  • Read about probabilities in the KB
  • Read more about the Monte Carlo method in our blog.
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