If you’re a stock or ETF trader, use this simple and quick calculation to help predict how much a stock is expected to move over a specified period of time.
As traders we train ourselves to decipher direction. Basically, we want to know where’s this stock going in the future? We use lots of tools–such as fundamentals, technical indicators, harmonic patterns, statistics, waves cycles, etc.–to help us pick which direction a stock is likely to move: up, down, or sideways.
But there’s another question that most traders never think to ask. That is: How much is this stock expected to move in a given period of time? There’s a very simple way to find this out, using the same method which is used by many professional traders (and this method costs you nothing).
Predict How Much a Stock Will Move – Requirements
In order to apply this method, the stock or security you are trying to analyze needs to be eligible for options. Option contracts can be complex to trade and understand, but provide a lot of information on market movement expectations. To check if your stock is option eligible, pull up a quote and try to find the option chain. If you are unsure how, a call to your broker’s customer service team may be a good idea. You can also go to CBOE.com, click on Quotes & Data > Delayed Quotes and then enter the ticker symbol of the stock or ETF you are interested in. If results pop up, your stock is optionable. You can also punch in a stock ticker on Finviz.com and on the bottom left of the “financial highlights” it tells you if the stock or ETF is optionable or not.
Predict How Much a Stock Will Move – The Method
Options contracts assign a monetary value to time, plus a whole pile of other factors measured by Greek symbols. Based on the price of time, we can extrapolate how much a stock is expected to move before a specific date. The output of this method is not the DIRECTION of the move, it is the SIZE of the expected move. That is, not where it will go, but rather how much it will move.
Pull up an options chain for your desired symbol, with an expiry date of at least 30 days from today. If this doesn’t make sense to you at the moment, it will in a second when we look at an example.
Look at the option strike price on the chain and identify the one that is closest to the current market value of your symbol.
Add the purchase price for both the call and put options of the strike price from above.
To the value from above, add the first call option strike higher than the one in step 2, and also add the first put option strike lower than the the one in step 2.
Divide the new total value by two, and voila – you have the dollar amount a stock is expected to move before 30 days.
Predict How Much a Stock Will Move – Example
Now let’s look at an example. Let’s try this trick on Apple (AAPL).
As of the close of business on Friday March 11th, 2016, Apple stock was trading at $102.26 a share.
Step 1 & 2:
Pulling up the options chain for April 15th of 2016 (just over 30 days from now) we see the following:
The closest price to $102.26 on the strike column is 100. Thus, we will use this row as our strike price for step 2.
The ask price for the 100 put option is $1.81. The ask price for the 100 call option is $4.1o.
The ask price for the first call option higher than the 100 strike (105 strike) is $1.55. The ask price for the first put option lower than the 100 strike (97.50 strike) is $1.11.
Sub total = $1.55 + $1.11 = $2.66.
Step 3 total = $5.91
New total = $5.91 + $2.66 = $8.57
Divide the step 4 total by 2. So $8.57 / 2 = $4.29
What does this mean?
This means that the options market is pricing in a $4.29 move in the stock of Apple by April 15th, 2016. The move is NOT directional, but only indicates the magnitude.
Your trading strategy and analysis tells you where the stock will go (direction), and now you know how much it is expected to move!
Predict How Much a Stock Will Move – Notes and Considerations
There are a few things to keep in mind. This method is not static, and each time there is a change in the expectation of volatility in your stock, the expected move will change, so it is best you re-calculate this value every couple days. If stocks are moving rapidly, you will want to calculate it daily if you are relying on this number for setting your price targets.
You can use this on any security which has listed options, such as stocks, ETFs and indices, etc..
You can also change the expiry time to find out what the expected move is for one week (if weekly options are available), next month, 3 months from now, etc.
For the more advanced options trader, you will notice this expected move is simply an average price of an at-the-money straddle and the first out-of-the-money strangle.
Why does this method work? Because all of these options will be comprised of mostly time value, and this value takes into account the expected move at the current volatility level.
We use this calculation for estimating target prices, choosing strike prices for our options trades, and much more. Now you can use it in your trading as well!
Good luck and good trading to all.
By George Papazov
George Papazov has over fourteen years of trading experience in currencies, stocks, futures and options. In 2012, he founded TRADEPRO Academy to offer traders a complete development package. Sign-up and get access to the first 8 lessons for free; over 12 hours of serious training for the serious trader.