How I use Bollinger Bands to pick strike prices when I trade vertical spreads.

Calculating Probability of Profit

If you are trading platforms which don’t give standard deviation or percentile markers, that can make it challenging to figure out the strikes to pick for high probability trades.

However, Bollinger Bands are a common feature on most charting platforms. Because of the mathematical precision and certainty underlying these indicators, it is an useful indicator for spread traders to use because it shows you where to place your two strikes with mathematical probability of a successful trade being on your side.

And every option trader knows it’s the math which makes or breaks a trade setup.

Bollinger Bands background

I think it can be said, without exaggeration that the Bollinger band, invented by John Bollinger is one of the most popular trading price volatility measurements in stock and option trading. Most famous successful traders tell you their secret sauce and then add “and I use Bollinger bands. “

John Bollinger creates this volatility measurement after years of study. But now it looks quite simple. He charted a simple 20-day moving average of the closing price with a band on either side consisting of two standard deviations of the moving average, effectively capturing about 95 percent of the variation away from the average.

How to use them to calculate probability of profit

The bands are, so to speak, moving standard deviations. By default, the Bollinger Bands ® are set to 2.0 Standard deviations which means that, from a statistical perspective, 95% of all the price action happens in between the channels.

For an options spread trader we often need the stock to finish above a certain price and below a certain price. The standard deviations from the mean represent large probability percentage zones and two standard deviation price points above and below the market represent the 95th percentile point in either direction. This means the stock has a 95% chance of closing above the lower strike and 95% chance of closing below the upper strike.

In times of volatility there is enough premium in these far ranges to make a $100 on ten contract and $200 on 20 contracts. If you create an iron condor you can sell both put spread and call spread, nearly doubling your profit.

If your brave and attentive you can just sell the options and save on buying the protective options and profit more. The statistical probabilities are on your side. Plus if the market moves against you and your probabilities change you can roll out to the next month, giving yourself more time yo be right.

✍️ @shortsegments.
Penned by my hand ✋