Understanding the Probability of Touch

We're all familiar with using delta as a rough-and-ready guide to the probability of an option finishing in-the-money (ITM). It's a foundational concept. But what if I told you there’s another, arguably more practical, probability that should be front of mind when you’re structuring a new trade?

I’m talking about the Probability of Touch (P.O.T).

This isn’t about where the stock finishes at expiry; it’s about the journey. P.O.T tells you the likelihood that the underlying’s price will hit your strike price at any point during the life of the trade. For active traders, especially those selling premium, this metric is vital to understanding the likely outcomes before entry. It’s the difference between a set-and-forget approach and a proactive, strategic management style that can sidestep trouble before it tanks your P/L.

Let's cut through the noise, examine how this metric is derived, and most importantly, how you can use it to build more intelligent, resilient positions on ASX-listed stocks.

P.O.T is (Roughly) Double the Delta

Think of an out-of-the-money option. For it to expire ITM, the stock not only has to touch the strike but also stay beyond it by the time the clock runs out. The Probability of Touch, however, only cares about that first part: the simple act of hitting the price.

Imagine a stock, let's say BHP Group Ltd (BHP), is trading at $45. You're looking at a short call option at the $48 strike. The delta might be 0.20, giving you a theoretical 20% chance of that option expiring in-the-money.

Now, consider the path the BHP share price can take over the next 45 days. It could rally up, briefly touch the $48 mark, and then sell off to close at $46 by expiry. In this scenario, the option did not expire ITM. But it did touch your strike. If you're managing the trade actively, that "touch" is a critical event. It’s a signal (or not!) to assess, adjust, or even exit the position.

Because the condition for "touching" is less restrictive than "expiring ITM," the probability is naturally higher. The widely accepted rule of thumb, or napkin math is that the Probability of Touch is approximately twice the delta.

P.O.T≈2×Δ

So, for our BHP example with a 0.20 delta call, the P.O.T is roughly 40%. This tells a very different story. While you have an 80% chance of the option expiring worthless, there's a 40% chance you'll have to deal with the stress and potential risk of the stock hitting your short strike price before that happens.

This isn't just a quirky theoretical relationship. It’s a risk management insight that has implications for how we trade ASX Options.

Thinking in Probabilities: Setting Up Your Next Trade

Understanding POT fundamentally changes your perspective on risk and strike selection. It moves you from a passive "will it or won't it expire ITM?" mindset to an active "what are the chances I'll be forced to make a decision on this trade?" framework.

For the Premium Seller: Defining Your Zone of Comfort

If you're selling premium through strategies like iron condors, short strangles, or credit spreads, P.O.T is something you need to consider. Your primary risk isn't necessarily expiry, but the interim period where price moves close to your risk strikes, then making a trade management decisions.

Have you ever entered an OTM credit spread, then felt uncertain when the market moved towards your risk strike?

The P.O.T provides a realistic percentage chance of your spread being tested. A 0.25 Delta option has a 50% chance of touching during the life of that option. It puts into perspective, you OTM Credit spread with the short strike at 25 Delta is going to get hit 50% of the time.

This doesn't mean the trade will be a loser—the price can touch the strike and reverse—but it does mean you need a game plan.

This is not something that will transform your trading 180 degrees, but the perspective of knowing that a 0.25 Delta options P.O.T is 50% should give you context on how the makret moves, what to expect during a life of a trade and affect how you manage your positions.

Elevate Your Decision Making with a Probabilistic Mindset

Moving beyond delta as your sole probabilistic guide is a significant step in learning and adapting in the options market. The Probability of Touch provides a more dynamic and practical measure of risk—the risk of being challenged during the life of a trade.

By incorporating POT into your trade selection and construction, you can:

• Set more intelligent strike prices that align with your tolerance for active management.
• Better anticipate the need for adjustments, turning reactive panic into proactive strategy.
• Gain a deeper, more realistic understanding of the risks inherent in premium-selling strategies.

The Probability of Touch is one of those numbers that drive the positions. It's a simple, yet profound, tool that can sharpen your edge.