I use a wide variety of tools when trading options, particularly when using options selling strategies. But there are only a few that I use with each and every trade I place.
One of those tools is the Expected Move, also known as the Expected Range.
As a quantitative trader who uses predominantly options selling strategies with a high probability of success, knowing the expected move of a stock or ETF prior to making a trade is integral to my overall success.
What is the Expected Move?
The expected move is the amount a stock or ETF is predicted to advance or decline from its current share price, based on the security’s current level of implied volatility and days to expiration. Additionally, the expected move fluctuates, in real time, based on changes in a security’s price and its implied volatility.
Simply stated, the expected move shows us the future expected range of a security over a specific time frame.
Let’s take a look at a quick example.
Below is an image of the SPDR S&P 500 (SPY) ETF. More specifically, we are looking at the options chain for the July 16, 2021 expiration cycle that has 31 days left until expiration.
The vertical, tan-colored bar represents the expected move for the expiration cycle. The current range is between 413 to just over 435. The market is essentially telling us that it expects SPY to close somewhere between 413 and 435 at expiration. Having this information prior to placing a trade is incredibly invaluable.
How I Use the Expected Move?
Okay, so knowing the expected move is between 413 and 435, I can place a trade outside of the range.
Options Selling Strategy: Bullish Approach
If I’m bullish and using a risk-defined trade, I can use a bull put spread, otherwise known as a short put vertical spread. My preference, in most cases, is to place the spread outside of range, in this case below the 413 put strike.
Oftentimes, I like to go well outside the expected range, thereby increasing my probability of success, or probability of profit. As you can see from the image above, by choosing the short put strike of 409, my probability of success on the trade is 74.99%. Of course, I could increase my potential probability by significantly more if I so choose.
For instance, if I chose the 406 put strike as my short strike, my probability of success increases to 78.20%. The only tradeoff is the greater the probability of success on the trade, the lower my overall premium at the time of the trade.
Options Selling Strategy: Bearish Approach
If I’m bearish and using a risk-defined trade, I can use a bear call spread, otherwise known as a short call vertical spread. My preference, in most cases, is to place the spread outside of range, in this case below the 435 put strike.
Again, my preference is to go outside the expected move, thereby increasing my probability of success. As you can see from the image above, by choosing the short call strike of 436 my probability of success on the trade is 85.98%. Of course, I always have the choice of increasing my probability of success.
For instance, if I chose the 438 strike as my short call strike, my probability of success increases to 88.61%. The only tradeoff, as I increase the probability of success on the trade, my premium, or potential profit,declines.
The expected move is just one of many important tools I use as a professional options trader. I reference the expected move for every trade I place and I suggest you get in the habit of doing so as well. Always, always, always understand what your probabilities are throughout the life cycle of each trade you place. Whether you are initiating a trade or managing the risk of your open position, knowing the expected move is an essential tool to your long-term trading success.