EV Fundamentals
Learn how FlashAlpha calculates expected value for options trades and why EV-based trading provides a statistical edge.
What is Expected Value?
Expected Value (EV) is a statistical concept that represents the average outcome of a trade if it were repeated many times. In options trading, EV tells you whether a trade has a positive or negative edge.
Formula:
EV = (Probability of Win × Win Amount) - (Probability of Loss × Loss Amount)
Why EV Matters
Most options traders focus on probability of profit (PoP). But PoP alone doesn't tell the whole story.
Example:
- • Trade A: 80% PoP, wins $100, loses $500
- • Trade B: 50% PoP, wins $200, loses $150
Trade A EV: (0.80 × $100) - (0.20 × $500) = -$20
Trade B EV: (0.50 × $200) - (0.50 × $150) = +$25
Despite having a higher probability of profit, Trade A has negative expected value. Over time, Trade B is the better choice.
How FlashAlpha Calculates EV
FlashAlpha uses a multi-step process:
1. Probability Distribution
We model the likely price outcomes for the underlying using:
- Implied volatility surface
- Historical volatility
- Term structure
- Skew adjustments
2. Outcome Mapping
For each possible price at expiration, we calculate:
- The P&L of your position
- The probability of that price occurring
3. Expected Value Integration
We integrate across all outcomes:
EV = ∫ P(price) × PnL(price) dprice
4. Risk Adjustments
Optional adjustments for:
- Early assignment risk
- Liquidity/slippage
- Commission costs
EV Display in FlashAlpha
In scan results, you'll see:
- EV - Expected value in dollars per contract
- EV% - Expected value as a percentage of max risk
- EV/Day - Expected value divided by days to expiration
Color Coding
- 🟢 Green - Positive EV (favorable)
- 🟡 Yellow - Near-zero EV (neutral)
- 🔴 Red - Negative EV (unfavorable)
EV-Based Trading Strategy
The Core Principle
Only take trades with positive expected value. Over a large sample of trades, you will be profitable.
Position Sizing
Size positions based on EV:
- Higher EV = larger position (within risk limits)
- Lower EV = smaller position or skip
Diversification
Spread your trades across:
- Different underlyings
- Different expirations
- Different strategy types
This reduces variance while maintaining your EV edge.
Common Misconceptions
"High PoP = Good Trade"
False. A 90% PoP trade can have negative EV if losses are large enough.
"EV Guarantees Profits"
False. EV is a long-term average. Individual trades can still lose. You need sufficient sample size.
"All Positive EV Trades Are Equal"
False. Consider EV%, holding period, and variance. A +$10 EV trade risking $1000 is worse than +$5 EV risking $100.