Tag: trade options

Visualizing the Expected Move

Understanding and charting expected moves based on implied volatility and option pricing can be a helpful tool for option traders.

The expected move is a concept that is important for option traders to understand and use. It took a while for me to grasp this when I started trading options, but now it is something I consider in trading on a regular basis. Expected move allows a trader to put into context what implied volatility and option prices are predicting for the future. While expected move isn’t a Greek, I’m including it in the group of Greeks because it is derived value from option prices and is closely related to some of the Greeks and the ways they are calculated.

Option prices increase and decrease with changes in implied volatility. Actually, since implied volatility is just an “implied” concept, Implied Volatility is the explanation of why option prices go and down after taking into account the other key pricing factors of time and price movement. Implied volatility is a percentage that represents the standard deviation of price movement for the next year, as implied by an option’s price. In any normally distributed data set, approximately 68% of the data will be within one standard deviation of the mean of the data. Stock prices aren’t typically normally distributed (they won’t perfectly fit in a bell curve), but for simplicity most people make the assumption that they are and understand the differences in outcomes to consider. I won’t dig any deeper down this hole, because for most purposes the statistics work pretty well for stocks and options, despite the simplifying assumptions that most traders make.

Options have the unique ability to express how the market in general expects prices to vary between the current time and option expiration. This is possible because the market of buyers and sellers settle on prices that balance risk and reward for future outcomes based on all currently available information. The result is that we can determine how much the market is expected to move in any timeframe, based on option prices. It is kind of like sports gamblers betting on the over/under of a game score- the betting line is determined by the cumulative expectations of those wagering based on what is known about the scoring and defensive ability of each team.

Ways to measure the expected move

One very quick way to determine how far the market is expecting the market to move by a given expiration is to add together the put and call premium of the option strike closest to the money. As I write this, the S&P 500 index (SPX) sits at 4108.54. The closest option strike is 4110. Looking 40 days out, the midpoint value of the 4110 call is 125.60, and the 4110 put is 123.15. Adding these together, we get 248.85. Why is this significant? Let’s say one trader buys these two options (a straddle) and another sells the two options. The break even is a move of plus or minus 248.85. Both the buyer and seller would feel like this is a fair trade. The market of buyers are hoping that the market moves more than expected, and the sellers are hoping it moves less. As a balance, it is a measure of the expected move.

Studies by TastyTrade.com show that this at the money straddle pricing often over estimates actual future moves slightly. For their TastyWorks.com trading platform, they use a modified formula that takes the at the money straddle and the first two out of the money strangle prices in a weighted average to calculate an expected move that historically is closer to the moves that actually end up happening. For the same timeframe, Tastyworks has an expected move of +/-263.83, so for some reason at the moment their calculation is slightly higher than the at the money straddle. Only a few trading platforms actually show an expected move calculation, and it is done differently at different brokers as there is no default standard.

How does this relate to implied volatility? Well, as it turns out the implied volatility multiplied times the price of the underlying stock can match fairly close to expected moves calculated by at the money straddles. The straddle or similar TastyWorks method come out to approximately a one standard deviation move. So a very quick calculation is to take implied volatility multiplied by underlying price multiplied by the square root of the fraction of a year until expiration. The square root part is a little much to begin with, but it is based in statistics and math. So, for our previous example, we will use the current VIX value for volatility of the S&P 500, which is currently 24.79. We have 40/365 of a year for 40 day move, and the square root of that fraction is 0.33. With the current SPX price still at 4108.54, we multiply by 24.79%, then by 0.33, and get 336.10. This would imply that the market is expecting something less than a one standard deviation move in the next 40 days. However, the calculated one standard deviation move is just 27% more than the TastyWorks expected move. For something that is “implied” from option prices and calculated in a couple of different ways, that actually is fairly close- close enough for us to have a ballpark estimate of what the market is likely to do in the future.

So, what is the best way to determine an expected move? Well, there is no right answer because no one really knows what the future holds. But, we know that more often than not, options are overpriced for the moves that eventually happen, so implied volatility will typically be more than realized volatility, so methods that show smaller expected moves will likely be closer over time. But to use the straddle method, a trader must have access to option tables for every expiration of interest and do calculation after calculation to see how the move evolves with time. Using the calculation of volatility and the square root of time allows a quick way to estimate moves over a broad range of time. For option sellers looking to “play it safe,” this calculation may encourage the choice of wider short strikes.

Charting Expected Moves

Once a trader understands the concept of the expected move, it often helps to see how this works out on a chart over time. Let’s look at a chart for early 2022 for SPX.

April 1 Expected Move
At the beginning of April 2022, we can see the expected moves for the next few months.

After a week we can see that the moves stayed inside the expected move. With another week of information, we can update our expected move chart.

As time passes, the expected move changes as well with new pricing information.

As it turned out, this period of time included a fairly strong bear move down that was outside the expected move for a while, but then returned inside.

expected move vs realized move
Using the original expected move, we can see how the realized move played out.

This example illustrates a point worth noting. The longer the time duration, the more likely that the realized move will stay within the expected move. Time allows probabilities to play out more.

Another factor with expected moves to consider is that implied volatility can vary significantly over time and those variations can dramatically impact expected moves of the future. Consider that an expected move when VIX is 30 will be twice as large as when VIX is 15. When implied volatility is high, the market is expecting big moves in the future. When IV is low, the market is expecting calm in the future. When the market gets volatile, it tends to take a lot of time to calm down. On the other hand, when markets are very calm, sudden changes can cause sudden spikes in implied volatility and future expected moves. It is far from an exact science, but it is the best real time future indicator of movement we have.

Regardless of how we calculate the expected move, it gives us a good idea of what the market currently collectively thinks the future movement of pricing will be. For planning option strategies, this can be very helpful.

The Power of Community

Traders need access to other traders to share, learn, and teach each other. Online social media groups can provide that type of community.

Let’s face it. Trading options can be a lonely task. It’s just a trader and the computer screen. Whom can a trader turn to with questions, for encouragement, or to share success and failure? Virtually every person who I dare to tell that I trade options as a primary activity either have no idea what I’m talking about, think I’m crazy, or both. Most people who do a lot of their own investing don’t even know what a put or call is. Traders need a community of other traders to keep their sanity and keep moving forward.

When I stop and think about it, I personally know seven option traders that I have met in person. Only seven. Four of them I met through one of the others. And only a few of them regularly do the same kinds of trades as me. And I feel lucky to know that many. So, personal connections can only help so much.

There are lots of online services that traders can pay a small fortune to join to help learn to trade options. Some are follow the leader- buy or sell what the guru says and exit when the guru says. I tried a few of those and found it hard to time it right and even then I didn’t get the results that were promised. So, I’m not a big fan of spending a lot to watch others trade.

If you do a Google search about any topic concerning options, you’ll be bombarded with ads for paid services, but then below them will be lots of YouTube.com videos, and other sites, maybe even this one. There are lots of quality YouTube videos on options, but many that are dubious at best. I first discovered TastyTrade.com through watching some of their YouTube videos. Tastytrade has their own channel on YouTube, and I’d encourage subscribing. One TastyTrader that I enjoy watching is “Sweet Bobby” Gaines. He has a “Sweet Bobby” channel on YouTube. Look around and search YouTube for option trading, and find your own favorites to follow.

But even watching others still doesn’t give you community. There’s nothing like interacting with others. This is where social media actually can be a help. A feature on Facebook.com that you may not be aware of is “Groups.” Just click on the Groups icon and either use the “Discover” icon or the search magnifying glass to look for groups that specialize in option trading. Some are more active than others. Most are private and require you to apply for membership- this is generally to keep out spammers and robots who will ruin the experience. I’ve joined a number of groups- some I’m active in and others not so much. For groups that don’t have members doing strategies I have in interest in, I simply drop my membership. I now have a number of virtual friends from these groups. Some of them message with me on an almost daily basis. I’ve discovered numerous trading strategies to try from posts in these groups, and the banter from members gives the members a wide variety of opinions about different trading scenarios, positive, negative, pointing out risk, ways to manage, and success stories.

Another social site that gained a lot of traction in early 2021 was Reddit.com. Reddit became an overnight sensation for traders when a little-known group on the site called “Wall Street Bets” essentially cornered the market on the stock of GameStop, an almost bankrupt video game store chain. By realizing that there was a huge amount of short interest in the stock and a small float of tradable shares, the group started buying up cheap shares of stock, and bigger buyers followed, driving up the price. Many short sellers, including some large hedge funds were caught flat-footed and had to buy back their short positions at huge losses, further driving up stock prices, a classic short squeeze. Call option buyers joined in as well and market makers hedged by buying increasing numbers of shares also driving up prices. By the time the craziness ended the stock was up over 100 times the price when the buying started. This crazy action drew attention to Reddit and the “Wall Street Bets” group. Like many, I joined both for the first time to see what the fuss was all about. The group membership ballooned to an enormous number and the content turned to mush- just a lot of nonsense posts slamming each other and promoting hundreds of other crazy schemes. I dropped my Wall Street Bets membership after less than a week.

However, Reddit has a feature that suggests posts from other groups that it thinks a reader might like. I found some other groups that I started commenting on that were more serious and in line with my view of trading. Again, I met a number of new virtual friends and engaged in both public and private dialogs about trading strategies. Groups on Reddit are public to read and join, so there can be a lot of spamming behavior and many users delight in being very foul-mouthed in their responses. Rudeness is tolerated a bit much, in my opinion. However, I’ve found that if I stay on the high road in my posts and stay factual and data focused, people generally engage back with me in a respectful way. It’s kind of a what goes around, comes around. In fact, the site has a measure called karma that is based on how well your posts are received by others. People who are mean and overly negative end up with negative karma and many of their comments get deleted by moderators.

Another social site that I’ve found helpful is Discord.com. Discord was started as a way for gamers to chat with each other in private rooms, and have discussions in groups on a private “server.” Once you join Discord, you can set up your own server, or join public servers set up by others. As it applies to traders, individuals will set up and organize a server and invite others to join. Many people have private servers by invitation only. Some of my local friends set up a server like this and invited me- I like the familiarity of the small group and we get along well with each other. I’m also a member of a number of other groups. A nice feature is that anytime someone posts a response to a server, I can have a notification pop up on my phone, or I can choose not to- the choice can vary from server to server. So, I have notifications on for some servers and off for others. The idea is that like-minded people can have an ongoing private dialog about their trading. Some conversations are based on users posting each of their trades for comparison and comment. So, a group of 0 DTE traders might each post their opening and closing trades, and then discuss what went right and what went wrong, critiquing themselves and other members on strategy. A Discord server can be very busy, or not busy at all- it depends on the number of users and how active they all want to be.

Twitter.com can be another source for information on trading. There are lots of famous and not so famous traders and information sources that tweet out information on a regular basis. I personally don’t have the bandwidth for it at the moment and don’t use it much. However, I know lots of traders love it. TastyTrade has a daily show, the Liz and Jenny show, where much of their discussion is based whatever Twitter posts use the hashtag #LizJny, which has fostered a community feel. Other shows on trading networks and CNBC have similar features and hashtags. Many high profile traders will respond to personal tweets or tweets that use an @ reference for them. However, the format really doesn’t lend itself to in-depth discussions. Often, it just allows tweeters to refer followers to content that the tweeter thinks is interesting.

I used to be a big fan of LinkedIn.com and its groups. Now, I think other social media resources have taken the lead in being sources of interaction with like-minded traders. I joined a few trading groups, and I have to say that I’ve been disappointed so far. Maybe new groups will emerge that will be better for the trading community, but I’m still waiting.

I know TikTok.com is gaining ground in this space as well. Similar to YouTube, TikTok offers videos, generally short in duration, and based on your reaction, the site steers you to similar content that might be appealing. As I write this, it seems a bit of an immature community currently, but by the time you read this in the future, TikTok could be the greatest resource available. We’ll see.

This is just a start. Feel free to leave your favorite way to get involved in the trading community in the comments below. New forums and sites are emerging all the time and providing new opportunities to connect with other traders. I’ll refrain from naming any specific groups on any particular site, because if you are reading this years from now because I haven’t updated it, there will likely be many new groups and sites to join and find community.

From my website Analytics, I can see that over half the hits to my site come from people clicking on a link to this site from a post someone referenced on a social media site. It used to be just me that did that on occasion, but lately others are finding this site and sharing it with their groups and trading friends. I really appreciate it when readers of this site find it helpful enough to copy a link from this site and share it with others. People seem to like the pages I have on my favorite trading strategies. I hope that you find some community here as well and find content worth sharing. Your comments are always appreciated, even it is a pain to leave them. It’s a challenge to have a site like this that doesn’t get nailed by spammers and hackers, so I have to put up some hurdles to allow comments.

Remember, the whole point of this post is to give you ideas about connecting with other people who understand the kinds of struggles you face as a trader, and give you a chance to give back to newer traders. Discussing trades on social media is the only place where I can discuss the merits of 20 delta short strike on a wide put spread, and know that most of the people reading will not only understand, but have an opinion to share back with me. That won’t happen at the next neighborhood block party. You aren’t crazy. There are people out there that get what you are trying to do and will be happy to have a discussion about it. You just have to know where to look. That’s the power of community, even when your community is spread around the world.

Rolling Losing Positions?

I recently responded to a social media post which asked why there is so much hate out in the social media world regarding rolling losing option positions. If you frequent any discussions about managing option trades, and someone discusses rolling a losing position, there will be some critic who comments to say that rolling options is horrible and locks in losses, and is a low probability trade, and basically is un-American. I sometimes get these kinds of responses myself, and if you read much of what I write, you know that I disagree with that. Rolling is a key part of many of my strategies including the rolling 7 DTE trade that I frequently trade. So, the following is my thoughts on rolling losing option positions.

As someone who rolls almost all my positions, win or lose, and often writes about it, my thought is that a lot of people that write negatively about rolling don’t really understand the benefits. It isn’t an issue that everybody should roll, or that nobody should, but more that it is a method that works well for a certain mindset. Some traders approach managing trades very differently and that’s great for them.

I think the issue is when the discussion comes to managing a losing position. There’s really three choices: hold, stop, or roll. A legitimate argument can be made for each approach, but I think the right answer comes down to the type of position that is in trouble, the trader’s view of the market probabilities looking forward, and personal preferences around risk and reward.

I roll my credit put spreads on SPX in virtually every situation. I want to avoid expiration drama, so I never hold to expiration. When I used stops in the past, it seemed like I got stopped out just as the market bottomed out and I found that frustrating. I now specifically seek out trades that accommodate rolling options and develop mechanical triggers on when and how I’ll roll a position.

For me the benefit of rolling a losing position is giving myself time and space to be right. I almost always collect a credit for a roll, so I’m paid to wait for a turnaround. Each roll improves the cost basis of my trade. When my position is being tested I try to roll both down and out for a credit, so that I don’t need a full recovery to come out with a profit. Since most of my positions are credit spreads, I do have an issue that if my position gets in the money, it is no longer able to roll for a credit, and I’m forced to pay a debit to stay in. Because my positions start at least an expected move away from the initial price, I rarely end up in the money paying a debit. I’ve found that with the trades I do, I collect credit 97-98% of the time, and the debits I pay have generally been about the same as the credit I get when I’m rolling a winning trade which happens much more often.

The big benefits I see from rolling credit spreads is that I keep time decay working for me 24/7. I don’t have to decide when to jump back in after being stopped out because I’m never out.

For those that say that rolling locks in a loss and puts you in a worse position, I understand that the act of rolling options, closing a losing trade and opening one is truly closing a losing trade. However, my new position is poised to earn all the loss back plus a profit beyond. Usually, when rolling a loser, the market is approaching an oversold situation and is increasingly likely to start back up. Since almost all my rolled positions are still out of the money, I usually still have positive expectancy and better than 50/50 odds of a profit. Market downturns are the best time to buy, so in many ways I’m forcing myself to buy the dip.

Rolling losing option positions does introduce a lot of volatility into a portfolio value. I get great returns through rolling, but my positions’ marked values go up and down more than many people can tolerate, and I understand. Every strategy for management has pros and cons, and some are no-goes for some traders. Each person has to find mechanics that match their tolerance for risk, and expectations for return.

It isn’t easy emotionally to roll in tough markets, but I don’t think it is any easier to take a loss when you are stopped out. I lost a lot just today, Nov 30, 2021, and did a number of rolls as part of my mechanics. However, I’ve been through this numerous times before, recovering fully each time, and built up cash reserves in good times, so that I’m ready for whatever the market is going to do.

Some types of trades just aren’t made for rolling options. For example I won’t roll a credit call spread that loses because I find they just compound losses as the market drifts higher more often than it falls, and it isn’t a fight I can win consistently. I don’t use rolls as much in individual stocks because moves can be extreme and last a long time. I don’t try to roll trades on expiration day because the numbers don’t work out. So I do have limits and don’t blindly roll every kind of trade. I find that many people critiquing rolling as a strategy are talking about one of these losing situations that even I won’t roll in.

I’ve had many people reach out to try to understand rolling options and from their questions I can see that it is a hard concept to grasp. I love it when the lightbulb comes on for someone, and it is also troubling when someone misses the point and drops a position, closing at the worst possible time. I usually get a few messages of a bad loss on days like last Friday or today, but I also get nice thank you notes from many more when the market goes up after a downturn and the person came out of a down market with a profit overall and their account at new highs.

I know my rolling approach isn’t for everyone and that’s okay. But it works for me. If it doesn’t work for you, then do what does work for you, and maybe learn a little more about rolling before you bad mouth it out of hand.

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