As discussed in the "Expected Move" post, the expected movement of a stock can be calculated with the following formula, where S subscript 0 is the stock's current price, IV is implied volatility, and the final term is the square root of days to expiration divided by 365:
Though an intimidating formula at first glance, it provides traders with the approximate range in which a stock's price may travel in a given amount of time or days to expiration (DTE). Note: The image above should say plus or minus preceding the square root sign.
To visualize, let's look at an example. Assume a SPY stock's price on low for the year on Feb 11th 2016 as $182.86, with an implied volatility of 28.14%. To calculate the expected move in 30 days, we substitute "DTE" with actual number of dates and solve for EM.
The plus or minus range for each expiration will approximately equate to the EM calculations using the mid-price fills of EM spreads and the MMM value.
. The expected movement of a stock's price can be computed/deduced in several different ways. Some of my 'go to' techniques are:
(a) Use the price of the front month (week) straddle. Here we check the price of selling the ATM call and ATM put. The expected movement of a stock's price when using a straddle strategy is the sum of the mid-price fills between the bid-ask spread for selling ATM calls and put.
Example: Say the ATM call has a bid/ask spread of $1.10 and $1.20, we can assume the mid-price fill of $1.15 similarly, say the ATM put has a bid/ask spread of $1.40 and $1.50, we can assume the mid-price fill of $1.45 So the straddle would cost $1.15 + $1.45 = $2.60 This would imply an expected move of $2.60 from the current price. Most seasoned traders will consider 80% of this straddle price ($2.60 x 80% = $2.08) as the expected move, I'd like to be a bit more conservative in my trading.
(b) Use of MMM (on ThinkOrSwim platform) MMM is the Market Maker Move displayed on the 'Trade' tab of the ThinkOrSwim platform. It's the expected move as computed by the platform.
(c) Use of expected move formula: Expected Move = Stock price x IV x Square Root (Days to Expiration/365.25)
(d) Use of option greeks: We look at delta to deduce the 1 Standard Deviation move in the front month. We'll look at the strike price of the options with 16 delta which equates to 68.2% probability of falling in the money or 30 delta which equates to 50% probability of falling in the money. By using these strike prices, we are deducing the probability of success.
Eighteen-year old trader, future connoisseur of options.
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