The Magic Of Options
As you'll hear us say in the Red Pill Quants Academy endlessly that is options give us many advantages over trading stocks. So many advantages that options are the instruments that most traders should be trading.
Probably the biggest advantage that options give us is the expected move. As the name implies, the expected move tells us how much a stock is expected to move. For weekly options that expire the current week, it tells us what the expected price range is for a stock between now and expiration. For the current week, that means this Friday at the close.
In the past, calculating the expected move required some looking at charts and sometimes doing some geeky math called interpolating. Let's take a look at the current options in SPY.
From the options chain in Think Or Swim, we can the current price of SPY is 329.06 (orange box) and the expected move when these options expire at the close on Friday 2/7/2020 is +/- 4.057 (the green box).
So what does this tell us? Today is Tuesday 2/4/2020 after the market close. Between now and Friday, SPY is expected to close on Friday between the current price of 329.06 +/- 4.057. With some math this works out to:
325.03 lower limit - 333.12 upper limit
With a long term 66% probability, this is where SPY is expected to be at the close on Friday. It can move higher or lower than these limits, but at the close on Friday, this is where it's expected to be. Paying attention to this gives us a huge advantage in our trading.
This is how the expected move works.
How Traders Use It
How traders typically look at the expected move is from Friday to Friday. For example, if today is Friday 2/7/20 and SPY closes at 335 and the expected move is +/- 10 for the options that expire the following Friday 2/14/20, this is what drives the markets. Not any other values.
A common trade many large firms do is a move called pinning. As the name implies, trading firms will ensure a stock is pinned to a specific price at expiration.
They will create options trades that are profitable if a stock stays within the expected move (or at a specific price). To ensure it does, they will often buy or short the stock to move the stock around so that it stays within the expected move.
As such, it's the Friday - Friday move that's really important. It's what professionals are watching and what drives the markets.
The Problem... If Today Is Not Friday
In the above example, we used the current value for SPY on a Tuesday, 329.06. And the expected move of +/- 4.057. That gave us these values for the range of SPY:
325.03 lower limit - 333.12 upper limit
The problem is today is Tuesday and not Friday. The stock has moved around a lot since last Friday, and so has the volatiltiy. So these values of 325.03 - 333.12 are different than if we would have done the same thing on the previous Friday 1/31/20 at the close.
In other words, these values don't do is a lot of good for looking at the expected move that drives that markets for the current week. To get that information, we would have to look at the option prices at the close last Friday and calculate the expected move.
Think or Swim allows us to do that, but it's a bit of work. So there is a much easier way, and that's using our Expected Move Tool.
What The Expected Move Tool Does
What the Expected Move Tool does is simple. It goes back to the close price of any stock on the previous Friday (or last trading day of the week for holidays) and computes the expected move from the options prices at that time too. Super simple!
It then plots it on a daily or weekly chart. Just like this.
This is a daily chart of SPY going back one year. For each week of 5 days, there are three lines, two red and one white. The white line is the middle value and the red lines are the upper and lower values. Now let's zoom in and look more closely.
If this looks a clown was coloring on an Adderall binge, don't be afraid. Let's break it down and look at the last two bars. We can see for the current week (the last two green candles on the chart), we have two candles. The white line, 321.42, is the middle value, which is the price from SPY at the close last Friday.
Today's candle is the last one, the green bar one closing at 329.06. And we can see from the Expected Move Tool, the limits for the week are 327.44 on the upper end and 315.64 on the lower end.
These 315.63 - 327.44 are the values that matter. These values are the ones that drive markets and we need to use in our trading.
These are a lot different than the 325.03 lower limit - 333.12 upper limit values we calculated above.
This is the magic of the Expected Move Tool. It's super easy to use! Install it, play around with it and you'll be a pro with it in no time.
How to Install It
Monthly Expected Move Indicator
For long term trades we also offer the monthly expected move indicator below: