An Essential Tool When Using Options Selling Strategies

Essential-Tool-When-Using-Options-Selling-Strategies

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.

expected-move-expected-range-SPY-options-selling-strategies

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.

stock-chart-SPY-June-2021

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.

bullish-put-spread-example

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.

bearish-put-spread-example

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.

Quick Summary

 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.

 

 

7 comments on “An Essential Tool When Using Options Selling Strategies

  1. Ahmad on

    I use thinkorswim platform for my option trades and where and how can I fine the Expected Move or Expected Range of prices for a stock or ETF option for an option cycle. Thanks,

    Reply
  2. Andy Crowder on

    Ahmad,

    Thanks for the question . On the Thinkorswim platform, if you go to the trade tab and look to the far right you will see the level of average implied volatility (IV) per expiration cycle. Just beside IV you will see the expected move or expected range in parenthesis. It will tell you the plus/minus (range) for each expiration cycle. You will notice that the further you go out in time, the greater the range. I hope this helps.

    Reply
    • Bill Keating on

      What value does knowing the Expected Move add to your trading if the Probability OTM is say 85%. If seems if I am primarily selling options and using a high percentage OTM, I am going to outside the range of the Expected Move. Is that a reasonable assumption?

      Reply
      • Andy Crowder on

        Bill,

        Thanks for the question. The expected move varies depending on volatility. Yes, in most cases going with a probability of success over 85% will put you outside of the expected range, but not always. Moreover, expected move is wonderful to use around earnings season when IV is inflated, since we know that 80% of all moves after earnings (in individual stocks) fall within the expected move or range. Knowing this info allows us to place our trade around the expected move. The key is don’t confuse expected move with probabilities of success. Hope this helps Bill.

        Reply
  3. Ahmad on

    Thanks so much Andy. This is something I did not know about and this expected range should greatly help in deciding to select strike prices before onset of a trade, and those strike prices should result in a profitable spread trade.

    However, in your experience, practically how good are these probabilities and expected ranges in making credit spread sales more profitable? I mean can we indeed rely on these numbers to really make money in the market in the long run???

    Reply
    • Andy Crowder on

      Ahmad, quantitative strategies are all based on hard statistics, like probabilities. Probabilities work, but you must be disciplined to allow the law of large numbers to work in your favor. Successful professional traders have been using probabilities for decades…and it’s the foundation, along with proper risk-management that leads to long-term success…and that’s the only thing that matters. Hope this helps.

      Reply
  4. Bill Keating on

    Thanks, Andy. That really helps alot! Will see if I can take advantage of that anomaly during Earnings. I have always shied away around that time. Maybe I don’t need to.

    Reply

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