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Calculation For How Much a Stock Is Expected to Move Over Any Time Period
As traders, we train ourselves to decipher direction. Basically, we want to know where a stock is 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.
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, and free, way to find this out. While expectations and outcomes don’t always align, being able to see how much a stock is expected to move is advantageous for setting reasonable profit targets and establishing a baseline for how long a trade may last. It is also one of the stock trading learning areas that all traders should have in their toolboxes to become successful and make more accurate decisions.
Predict How Much a Stock Will Move – RequirementsCopy link to section
In order to apply this method, the stock or security you are trying to analyze needs to be eligible for options trading. To check if your stock is option eligible, pull up a quote and try to find the option chain. Go to CBOE.com, click on Quotes > 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 stocks or ETFs are optionable or not.
Predict How Much a Stock Will Move – The MethodCopy link to section
Options contracts assign a monetary value to time, plus a whole pile of other factors. 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 and choose an expiry date in the future. 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 prices on the chain and identify the one that is closest to the current market value of your symbol.
Add the purchase price (called the premium) for both the call and put option of the strike price from step 2.
To the value from above, add the premium of the first call option strike higher than the one in step 2, and also add the premium of the first put option strike lower than 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 over that time period.
Predict How Much a Stock Will Move – ExampleCopy link to section
Let’s try this trick on Apple (AAPL).
As of the close of business on April 11, 2018, Apple stock was trading at $172.44 a share. The following quotes come from CBOE. Click to enlarge.
While we will use current figures for this example, but the process is the same tomorrow, a week, or 10 years from now. You just need to use updated numbers per the steps.
Step 1 & 2:
Assume you wanted to know how much the stock could move between now and the end of May. Pulling up the options chain for May 25th of 2018, about 6 weeks from now, we see the following:
The closest price to $172.44 on the strike column is 172.5. Thus, we will use this row as our strike price for step 2.
The ask price for the 172.50 call option is $6.60. The ask price for the 172.5 put option is $6.80.
The asking price for the first call option higher than the 172.5 strike (175 strike) is $5.35. The ask price for the first put option lower than the 172.5 strike (170 strike) is $5.70.
Step 4 = $5.35 + $5.70 = $11.05.
Step 3 = $13.40
Combined total for step 3 and 4 = $13.40 + $11.05 = $24.45
Divide the step 4 total by 2. $24.45 / 2 = $12.23
What does this mean?
It means that the options market is pricing in a $12.22 move in the stock over the next six weeks (from now until the option expires). The move is NOT directional, it only indicates the magnitude. If we divided $12.23 by $172.44 (recent closing price), we can see that the data calls for an estimated fluctuation of 7% away from the current price over the next 6 weeks.
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 ConsiderationsCopy link to section
This method is not static. Each time there is a change in the expectation of volatility in your stock, the expected move will change. If you are relying on this value, it is best to re-calculate it every couple days.
You can use this on any security which has listed options, such as stocks, ETFs, and indexes.
You can also change the option expiry date to find out what the expected move is for one week, 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. You should also combine this with other methods to reduce stock investing risks to master your trading strategy.
This calculation is different than an Average True Range (ATR) reading for example, which only looks at prior movement over a time period. For example, a 6-week ATR at this time is about $15.74. Our calculation for movement over the next 6 weeks is $12.22. Both methods have their uses, but they are not the same.
As indicated at the start, this is what options traders are pricing in for an expected move in the stock. That doesn’t mean that is what will happen. Options traders could be wrong, and we could end up seeing much more volatility, or less. Your own analysis may indicate something very different than this number, and if you trust your analysis then you may be able to make money (or lose) by taking advantage of what other traders aren’t pricing in.
You can use this calculation for estimating target prices, choosing strike prices for our options trades, and much more. It is an estimate, and a good baseline to start from. But if you have other conflicting evidence, you will also want to consider that.
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