Lesson Overview

What's The Expected Move?

Calculating the expected move is a great tool to use when determining how far OTM to sell options for an earnings set-up. And this quick tutorial will show you how to use the the weekly ATM straddle options for pricing to help figure out how far the stock is likely to move following the company's earnings announcement.

Again this does not guarantee that we are able to correctly predict the possible range but we can get a very high confidence range based on how we calculate the expected move. This should enable us to consistently make 70% probability of success trades.

More Discussion

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  • Great comment and thanks for the link!

  • Awesome thanks for sharing – great insight!

  • Izzy

    Hey Kirk, what option price do platforms use to calculate overall Stocks Implied Vol? Is it front month( the closest expiration) at the money option’s price or what?

    • Depends on the platform. Most platforms use a combination of ATM and slightly OTM option prices to determine volatility. More emphasis is placed on ATM options though.

  • Eli Cepeda

    Hey Kirk, I just want to let you know how much I am enjoying all your videos. Thanks

  • It’s just a traditional easy way to roughly calculate the expected move based on a normal distribution equity curve. All we do is add the price of the front month ATM call and the price of the front month ATM put, then multiply this value by 84%. Yes sometimes earnings trades don’t make enough to cover this distance in which case it’s a pass on the trade.

  • Combined probabilities.

  • Erik

    Kirk:

    I was taught previously that 1 standard deviation is 68.2%. You mentioned that 84% is a 1 standard deviation move? Or are you talking about probability of success? Thanks, Erik

    • Yes I was more referencing selling at a roughly a 16 delta on each side or 84% probability of success.

  • Erik

    Thanks for the clarification! Have a great weekend, Erik

  • Chuck

    FWIW – You get the same answer if you simply multiply the price of the ATM straddle by 0.84 The dividing and then multiplying by the underlying price cancel each other out.

Show Video Transcript +

I wanted to quickly record this video talking about expected move because we just made an earnings trade about 10 minutes ago and we sent out the alert to our members.

It's a great example of how you can use option pricing and straddle pricing to calculate expected a move. But I’m also going to show you a couple of tips because, inside Thinkorswim, they already do this for you, so you don't have to do it yourself in most cases.

We’re looking at the stock today of MON which is Monsanto, and we’ve traded this a bunch of times before, have been very profitable for us trading this around earnings, and you can see that the stock does have earnings which come out tomorrow.

As we always do with these earnings trades, we’re trading it just the day before the stock announces earnings which are tomorrow before the open, so we just made the trade.

It’s about 3:45 in the afternoon before the market close, so as for close as we can get towards that end of the day as we talk about all the time.

When we go in to look and see where the stock might go, we’re going to go to the trade tab, and I’ve already got up our position here with Monsanto, and you can see this is the exact trade price that we have.

We sold a strangle on the weeklies, and we did so at the 121 calls which you can see here and then also the 112 puts which you can see here on the screen. Everything that I'm showing you here obviously lives and working orders.

Inside Thinkorswim, it’s got a cool feature, and you're able to just visually see what the expected move is by just going over here to this MMM that shows up as earnings come up for a particular stock.

This MMM is the market-maker move for this stock, and it’s telling you up or down what the expected move is for this stock for earnings.

This is subjective because people always ask and they’re like, “What does that expected move mean? I understand the stock could go up or down by about $2.94, but what does that encompass?”

That encompasses about a one standard deviation move, and as you’ve probably seen in a bunch of our videos, that’s pretty much how most of the probability indicators are calculated with this one standard deviation move.

Right now based on the pricing of Monsanto… And we always take the closest contract pricing. In this case, it’s the January weeklies which only have about three days left.

Based on all of this pricing and data for the stock and it’s very liquid, it’s got a lot of shares, the market is pricing in that at earnings, it could move somewhere between $3 up or down based on its current price.

This is helpful because as you can see, what we've done is we've gone just a little bit beyond that level on both ends to give ourselves enough room to be right on this trade.

We want to make this trade with as high of a probability of success as possible, and we’re probably looking at about a little over a 70% chance of success. The probability that it moves down below 112 is about 14%, and the probability that it moves above 121 is about 14% as well.

Give or take with the market moving here; you can see we’re pretty neutral and balanced to the trade and the position right now.

But one question that I get often is, “Kirk, what if my broker doesn't have that MMM up there in the top right-hand corner? What if I have to manually calculate where the position is?”

I’m going to show you a cool way to do that, and it has to do with using the at the money straddle price. What we’re going to do is… And I’ll go over two different examples, one live and then I'll show you a different example with Twitter in just a little chart that we have.

But one way you can do it is you go to the at the money straddle. In this case, we’re going to go to the closest strike that's for the money and with the stock trading live right now at 116.74; we’re going to go to the 117 at the money straddle.

We’re just going to go in here and right click and pretend like we’re going to sell that at the money straddle. It’s going to bring up this pricing dialogue box down here, and you can see now that the credit for the at the money straddle is $3.25.

That’s the credit that we’re going to work with. Here's the formula for how to calculate any expected move and you can do it with any probability range you want. You take the credit that you see down here and in this case, that credit is $3.25.

I’m just going to write it out on the screen here so that we can see it. We take that $3.25 credit, we times that credit by the probability that we want to see.

In this case, we want to do a one standard deviation move which is the 84% probability range, so we’re going to times the credit down here which is $3.25 by our expected range which is 84 and then we’re going to divide that figure by the current stock price.

We’re going to divide that figure by the current stock price which is 116.78. Hopefully, you can see it here. I know I’m drawing just right on the screen, but I just want to make sure that you guys can see how to do this.

We take the credit of the at the money straddle which is currently the closest strike at 117, we times that first by the probability that we’re looking to get, that range that we’re looking to get, an 84% chance of success range and now we take that probability if we want to get that expected move, we want to take that probability and we want to divide it by 116.78.

If you go ahead and do this… And I’m just doing this on my calculator on my phone right here. 3.25 times .84 divided by 116.78 gives us an expected move percentages of 2.337.

That’s the expected move percentages that we’re looking at. You can take that percentage and then times that percentage by saying, “If the stock is expecting to make a percentage move of about 2.337, what does that equate to in dollar terms?”

We take that percentage move and we times it by 116.70 which is where the stock is trading right now, and that gets us an expected move of about 2.72. And I just wrote it up here in the top right-hand corner, about 2.73 kinds of rounding up.

This is a really good way to use just the at the money straddle price to calculate a pretty good estimate of where the stock might go in its expected range. This doesn’t mean that this is going to be more exact or less exact.

You can use either of these numbers, and you see they’re only off by about $.20 or less. Both of these calculated out are pretty easy, but if your broker platform doesn't have the ability to calculate expected a move, then you can use that at the money straddle and calculate it out yourself.

You’ll want to do this towards the end of the day. As you're going in to make a trade, you don’t want to do it in the morning. You want to wait towards the end of the day and try to get as neutral as possible by waiting and minimizing the time gap in the trade. But this is an easy way for you to calculate out expected move.

Another way that we can do it is by using an example of Twitter. I’ll just show you this because it's easy to visualize instead of me drawing on the screen here. Here is just an image that we have that we took which shows expected a move.

And this just shows the formula if, for example, the Twitter stock is currently trading at $38.38 which it’s not right now, but if it is, we take the 38.5/38.5 straddle which would be the closest to at the money. We’re taking that at the money straddle, and that price of that straddle is $4.54.

We take that price for, $4.54, we times it by the expected range that we want to get which is 85 or 84, you can even do this, times it by .9 to get a 90% confidence range if you want to be even more conservative in your pricing and your selection of strikes, and then we divide it by Twitter’s current stock price which is $38.38.

That’s how we get this percentage move. Based on all of this math, if you are trading Twitter at the time that we did this video and at the time that these prices are up here, you'd expect a move of up or down 10% in the stock after earnings.

It’s an easy way to do it. You can look in the market-maker measure inside Thinkorswim if you have Thinkorswim, but you don't need them to make this type of calculation and to figure out what any expected move is of a stock going forward.

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