I've been paper trading options for few months now and I still havenít figure out an exit strategy.
Recently I encountered the probability density function for the lognormal random walk derived from a stochastic differential equation. Apparently this can be used to calculate the probability of the underlying asset price being in a certain range at a certain time. So I can estimate the probability of winning given that I know the range which makes a profit.
From the look of this equation it requires the current asset price, the volatility and the drift rate also known as the expected return or the growth rate. These variables are also used in the binomial pricing model as well. I would like to know how to calculate the last two variables, the volatility and the drift rate (anyone who use the binomial pricing calculation probably familiar with them) . I donít know whether I should be using the implied volatility or the historical volatility for the volatility. These variables seem all subjective.
I am aware that quantitative methods do not always match the reality due to the oversimplification of the model and other issues. But Iíd like to have it as an approximation and a safety net. Please let me know if there are any good exit strategies. I much appreciate it.