Expected Move: Sanity-Checking Trade Ideas
Mar 21, 2019
While it sometimes gets lost in the volatility shuffle, Expected Move is a valuable metric that options traders can use to sanity-check potential positions - or even to reevaluate existing positions.
Fortunately, the math behind the expected move calculation isn't that complicated. The inputs needed when calculating this important metric are:
stock price (SP)
current implied volatility (IV)
days until expiration (DTE)
Once a trader has identified the above numbers, they can be plugged into the following equation: (Stock Price) x (IV/100) x [square root (DTE/365)] = Expected Move.
Before we jump into a potential interpretation of the expected move metric, let's take a look at a simple example. For instance, imagine that SPY is trading $279, and implied volatility in SPY is 15, while the days-to-expiration for the option(s) is 45.
Plugging those values into the expected move calculation, we get: (279) x (15/100) x [square root (45/365)] = +/-14.69
Now that we have a value for expected move, we can apply this number to a hypothetical trading scenario.
Let’s say a trader was considering a short straddle in SPY, with 45 DTE, and the underlying trading about $279. The trader might feel different degrees of confidence if he/she could sell the straddle for $8 as compared to selling it for $16.
Referring back to expected move, the options market is implying there's a 68% chance that SPY closes between 264.31 and 293.69 (that’s 279 +/- 14.69). This range encompasses a one standard deviation move. To capture 95% probability (that SPY closes within the range over that period), one would simply widen it by another 14.69 on both sides. And for 99% probability, the range would be widened once again by 14.69.
Regardless, most option traders are comfortable being right 68% of the time, which is why a one standard deviation move plays such an important role in decision making.
Applying 14.69 to the potential straddle sales prices of $8 and $16, one can see how expected move can serve as a very valuable resource when evaluating potential trades. In this case, a trader probably would not consider selling the straddle for $8, but might strongly consider a sale at $16.
The nice thing about expected move is that it moves the discussion past implied volatility, which may seem slightly convoluted at times, and frames the risk-reward proposition into terms that can be easily analyzed.
Traders seeking to learn more about expected move may want to tune into a new episode of Options Jive which focuses on this precise subject. On the show, the hosts walk viewers through not only a comprehensive review of expected move, but they also show how expected move changes when implied volatility gets “shocked.”
If you have any questions about expected move, don’t hesitate to leave a message in the space below, or email us directly at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.