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Mar 21, 2019

Expected Move: Sanity-Checking Trade Ideas

By:Sage Anderson

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 support@tastytrade.com.

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.

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