How to Calculate Maximum Probable Loss in Finance
Maximum probable loss (MPL) has many meanings. In the insurance industry, it refers to the maximum loss that may occur from a disaster. In terms of finance, maximum probable loss usually refers to the maximum loss incurred as a result of a fall in price of a certain asset when backed up by a "put" option such as an option or a futures contract. With such contracts, an asset such as a stock, would be automatically sold before its price fell further, establishing a maximum probable loss from any fall in stock price.
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Instructions
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1
Calculate the total value of assets at the time of purchase. For example, if you bought 100 units of stock at $60 each, multiplying 100 by $60 gives $600.
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2
Add the price of the futures contract to the total value of assets during the time of purchase. So, if you purchased a futures contract that covers 100 shares for $2, then the total amount spent during the initial transaction would be $602.
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3
Multiply the strike price of the futures contract by the number of shares purchased. If the strike price is $50, then multiplying by 100 gives $500. When the price of the stock falls to the strike price or below, the stock is automatically sold.
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Subtract the result of Step 3 from that of Step 2 to arrive at the MPL. Using the same example, subtracting $500 from $602 gives a maximum probable loss of $102. So, if the price of the stock were to continue to fall to $30 per share, then you would have saved losing $200, less the $2 fee, by purchasing the futures contract.
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