Probability of Profit (POP) for Options: How It's Estimated and Where It Fails
Probability of Profit (POP)
POP is the chance a trade finishes at or beyond breakeven at expiration, under a lognormal model priced from implied volatility. Enter a fictional EXMPL trade.
How it works, and its limits
- POP = probability price ends past breakeven, using N(d) with implied volatility. Brokers use similar models.
- The delta shortcut treats a strike's delta as the chance it finishes in the money. It ignores the premium, so it's more conservative for sellers.
- POP says nothing about size: a 85% POP trade can lose several times what it makes.
- Real prices have fatter tails than the lognormal model, and IV changes after you enter.
- POP at expiration differs from the chance of touching a price before then (roughly double).