Use the IB Probability Lab to analyze the market’s probability distribution, which shows what the market believes are the chances that certain outcomes will occur. This tool can be used to locate potentially profitable trading strategies for stocks and options in the event that your view on a stock is different from that of the market. This lesson will explain how to navigate and utilize the Probability Lab.
The IB Probability Lab is a Trading Tool to help explain the current relationship between the price of a
stock and options traded on it.
Usually the Market Price of a stock and the Implied Prices derived through the options market are very
Therefore, the option market tends to be in agreement with the cash value of a stock. In other words,
there is no likelihood of a profit at prevailing option prices in the event the stock’s price stands still
because the two markets are usually aligned.
The IB Probability Lab becomes extremely useful when investors have a different view on the outlook
for a stock. By customizing the forward price or the level of implied volatility you will find that the value
of options in the market will change. In short, the Probability Lab can be used to locate potentially
profitable trading strategies for stocks and options in the event that your view on a stock is different
from that of the market.
In the Probability Distribution Builder enter any US stock symbol in the Ticker Entry field. Then from the
Expiry Selection field choose a suitable time horizon to see the bell curve distribution displayed in the
plot. This describes the option market’s prevailing prediction for the price of the stock at the chosen
expiration date. It tells us the likelihood that a share price will land within a specific price range by the
end of the life of the option used.
Use the up or down arrows on the Custom line to change the terminal value for the stock at option
expiration. Alternatively, use the up and down arrows to change the implied volatility reading for the
stock in the same way. Doing so changes the shape of the bell curve or Probability Distribution. Don’t
forget that Wall Street analysts typically have 12-month price targets for most companies, which you
could use to test for opportunities in the market for stock options.
Let’s take a stock trading below $60 with intrinsic value of about 20% and assume its price by the end of
the year will be lower while its volatility will be higher. As I make those two adjustments, note the
display of a second probability distribution curve in contrast to the current market view. By customizing
the outlook all we have done is rearrange the likelihood of prevailing outcomes. We have assigned
stronger chances of a more volatile stock price in the near future. In turn this is reflected in predicted
option premiums and by clicking on the Build Strategy button, the technology will display any available
strategies that might do well in the event our prediction comes good.
The probability Lab consists of four windows.
1. As you just saw, the Probability Distribution Builder can be used to build a custom view in
contrast to the market’s current outlook for a given stock price.
2. The Strategy Scanner ranks system-generated stock and option strategies and allows users to
compare market versus customized probabilities. Here you can view maximum returns and losses
associated with each strategy and see the impact on account margin. You will also see breakeven values
associated with individual strategies. Please note that the breakeven values do not take any
commissions into consideration.
3. The Strategy Adjustment and Order Entry panel allows you to make any changes to the
strategies returned by the technology. For example, you can change the ratio in a combination trade,
consider a different expiration date or strike price and review the impact it might have on the profile of
the strategy. Upon review you could select the appropriate Order Type and price for your trade and
enter the order.
4. The Strategy Performance Detail view allows you to look at expected profit and loss associated
with any of the strategies and compare one against another to determine if it’s the right trade for you.
The default view examines the P&L at expiration for the chosen strategy, but you can also view the
expected P&L on any day through expiration by selecting it from the date dropdown menu. You can also
view Delta and other Greek values from the input selector field from this window. Once again this can
be shown at any time horizon through expiration.
Please note that multiple leg strategies, including spreads, will incur multiple commission charges,
possibly having an effect on trade P&L.
Disclosure: Interactive Brokers
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Supporting documentation for any claims and statistical information will be provided upon request.
Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.
Disclosure: Options Trading
Options involve risk and are not suitable for all investors. For more information read the “Characteristics and Risks of Standardized Options” also known as the options disclosure document (ODD). To receive a copy of the ODD call 312-542-6901 or click here. Multiple leg strategies, including spreads, will incur multiple commission charges.