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Understanding and calculating the expected move of a stock/etf/index
Equities
Koen Hoorelbeke
Investment and Options Strategist
Summary: Whether you're an investor or a trader, understanding the expected move of an asset can provide valuable insights into market expectations and potential price fluctuations. By looking at options we get better insights on how the market anticipates current and future movements of any asset like stocks, etf's, indices and more
Consider a stock that's currently trading at $100. If the expected move over the next month is $5, this means the market anticipates the stock could reasonably trade between $95 and $105.
For example today's expected move of the Nasdaq is plus or minus $126.07. Compared with it's expected move of yesterday, which was at $85.18, we know by looking at those numbers that the market anticipates a more volatile day than yesterday.
Another example could be the expected move of Nvidia. Suppose you want to know where the market thinks Nvidia will be trading during the coming year. Using options/implied volatility you can calculate that the market expects Nvidia will be in a range of it's current price of $421.03, plus or minus $146.72.
Does this mean that the price of Nvidia will be between $274.31 and $567.75? No! It could, but it's certainly not a garantuee. It's just an indication of a range where the stock will be trading in, according to market expectations at this moment.
What is the Expected Move of an Asset?
The expected move of a stock or any other asset is a range within which the price is likely to stay over a certain period, based on the market's current expectations.
It's a concept derived from options pricing and reflects the market's collective prediction of the stock's volatility. The expected move is useful for any investor or trader looking to understand potential price ranges.
How to Calculate the Expected Move
There are two common ways to calculate the expected move:
Using Implied Volatility: The standard method involves using the stock's implied volatility. The formula is:
Expected Move = Stock Price * Implied Volatility * Square Root of (Time until expiration / 365)
Expected Move = Stock Price * Implied Volatility * Square Root of (Time until expiration / 365)
Using the formula above:
Stock Price (AEX index in this case): 753.39
Implied Volatility (mid volatility, showed in the option chain): 13.86
Time until expiration: 42
Expected Move = 753.39 * 13.86/100 * square root of (42/365) = +/- 35.42
The Quick and Dirty Way: A simpler method involves looking at the price of an at-the-money (ATM) straddle
(a strategy that involves buying a call and a put with the same strike price and expiration date).
This method is less precise but can be calculated quickly and easily.
Using the quick calculation:
Expected Move = (13.30 (cost of ATM Call) + 16 (cost of ATM Put) ) = +/- 29.3
How to Use the Expected Move
The expected move can be used differently by investors and traders:
For Investors:
- The expected move can help investors assess whether their expectations align with the market's predictions. If in the example above you think the AEX will go above 850, you know that your expectations are a lot higher than what the market thinks (753 + 35 = 788). Are you too optimistic, or do you know something the market doesn't know? Are you right or is the market better at predicting? Only future will tell. But at least now you have an extra indicator.
- It can also be used to help set take profit or stop loss levels that are in line with market expectations. For example, if you are bullish on the AEX (in the coming 42 days) and you set a stop-loss at 740, you know that this stop-loss could easily be hit as the market anticipates a bigger move in that same time-frame.
- Comparing with previous expected moves of earlier timeframes, it can show whether or not the current timeframe will be more volatile/eventful.
For Traders:
- For options traders, the expected move can guide the selection of strike prices for a lot of strategies like vertical spreads, strangles, iron condors, and many more. For example, a very common way of determining the width of a short strangle is to sell the call and the put outside of the expected move range. In the example above you would set the strike of the call at >785 and the strike of the put <725.
- Another common use is to see what the market expectations are around important events, like earnings reports, or inflation numbers being published.
- Like investors, traders can also use the expected move to check if their expectations align with the market's.
Conclusion
Understanding the expected move of a stock can provide valuable insights into market expectations and potential price fluctuations. However, it's important to remember that the expected move is just that - an expectation. The actual price movement can sometimes be far off from the expected move, especially in volatile markets.
As with any tool, the expected move should be used in conjunction with other analysis methods and not relied upon in isolation.
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