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One of my favorite trading tools as a statistically based trader is the Expected Move, also known as the Expected Range.
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. The expected move fluctuates, in real time, based on changes in a security’s price and its implied volatility.
Let’s take a look at a quick example.
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Below is an image of the Russell 2000 (IWM) ETF. More specifically, we are looking at the options chain for the June 3, 2022, expiration cycle that has 30 days left until expiration.
The vertical, tan-colored bar represents the expected move for the expiration cycle. The current range is between 175 to just over 200. The market is essentially telling us that it expects IWM to close somewhere between 175 and 200 at the end of the June 3 expiration cycle. Having this information prior to placing a trade is incredibly invaluable.
How Do I Use the Expected Move?
Okay, so knowing the expected move is between 175 and 200, I can place a trade outside of the range.
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 175 put strike.
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 170, my probability of success on the trade is 81.50%. Of course, I could increase my potential probability by significantly more if I so choose.
I also like to look at the probability of touching my chosen strike. In this case, the probability of IWM touching 170 at some point within the June 3 expiration cycle is only 35.92%. I look at probability of touch as kind of a stress indicator. In most cases, I look for a probability of touch below 50%, as I want to keep the stress low when using a high-probability trading approach.
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 above the 200 call strike.
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 202.5 my probability of success on the trade is 86.34%. The probability of IWM touching the 202.5 strike in the next 30 days is 27.94%
Of course, I always have the choice of increasing my probability of success.
For instance, if I chose the 205 strike as my short call strike, my probability of success increases to 90.40%. The probability of touch falls to 19.59%. The only tradeoff as I increase the probability of success on the trade is that 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.