Sunday, April 20, 2014

how to tell if your vertical debit spread is in the kelly zone

in a vertical debit spread you are paying upfront for a combination of long and short options. to tell if the price you are paying for the spread falls into the positive kelly zone the risk you pay upfront for the reward must be low enough. here is the the formula i use to determine where this even-money price point is:
e = p * w
  • e is the even-money price
  • p is the probability of success
  • w is the width of the strikes
for example, if you are pricing a put vertical on spy that has a width of $1 between the long and short options and the tos analyze tab shows a probability of success of  54% then the  price one should pay to be at even-money is 54 cents. if you can get it cheaper then you are in the kelly-zone, where the kelly formula will give a positive number.

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