Options Strategist
Summary: Our weekly Volatility Report provides a comprehensive overview of expected price movements and evaluates the implied volatility rankings for upcoming earnings, key indices, and ETFs. In this edition, we delve into potential trade setups for a curated selection of ETFs and stocks, including SPY, QQQ, IWM, and SHOP. Particularly for SPY, we highlight a trade setup suitable for hedging strategies, offering a strategic approach for those who may have concerns about the current market peaks and seek to safeguard against downside risks.
Welcome to this week's Volatility Report, a guide for traders and investors seeking to navigate the dynamic world of stock market fluctuations. In this report, we list the expected movements and implied volatility rankings* of stocks with upcoming earnings announcements, as well as key indices and ETFs. In this edition we'll also have a look at some possible trade setups for a selection of ETF's and stocks in the list; SPY, QQQ, IWM and SHOP
Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.
Expected moves**, derived from at-the-money strike prices post-earnings**, indicate potential price volatility.
In the table above you'll find the following data:
The list contains 4 highlighted stocks which each have 3 trade setup ideas (bullish, neutral, bearish). These ideas are listed below.
In this section of our volatility report, we're focusing on three credit and/or debit strategies that align with various market outlooks for our featured stocks. For each stock, we present a bullish, neutral, and bearish trade setup, designed to match your expectations for the stock’s future price action.
Think of these strategies as starting points to shape your trading plans. Each setup is flexible – you can adjust the strike prices and the widths of the spreads (set by default at $5) to suit your trading needs. The credit spreads we've chosen are bold, with strike prices set near the current price of the stock to seek higher rewards at increased risk. Feel empowered to place these strikes further away or closer based on your own market analysis and confidence.
Remember, these setups are foundational guides. It’s essential to refine them to fit your individual trading style and outlook, ensuring they support your trading objectives and risk management preferences.
This report outlines three trade setups for the SPDR S&P 500 ETF Trust (SPY) to align with varying market conditions. While the bullish and neutral strategies are designed for specific market movements, the bearish setup is particularly notable as a hedge. With an expiry six months from now, the purpose of this bearish debit put spread is to act as insurance against potential significant market corrections. This setup can provide portfolio protection by offsetting losses during unexpected downturns.
These trade setups provide a strategic approach based on varying market outlooks, each with their own risk profile and potential rewards. The credit put spread and iron condor are premium collection strategies that benefit if the underlying remains within a certain price range, while the debit put spread is a directional trade that profits if the underlying decreases in price. The margin impact, maximum risk, and maximum profit for each setup must be considered in the context of the trader's individual risk tolerance and market expectations.
For each setup, the maximum profit is the premium received, and the maximum risk is the difference between the strikes minus the premium. The breakeven points indicate the stock price at which the trades will neither gain nor lose money at expiration. The margin impact reflects the required capital to maintain the positions, which varies according to the broker's margin requirements.
In these setups, the first and second strategies involve selling premium to potentially profit from the time decay if the underlying index remains within a certain range by expiration. The third strategy is a directional trade where the trader is bearish and expects the price to drop. The premium received or paid indicates the maximum potential profit or loss, while the difference between the strike prices minus the premium indicates the maximum risk. The breakeven points are crucial for determining at which stock price the trades will neither gain nor lose money at expiration. The margin impact reflects the necessary capital to enter and maintain the positions, according to the broker's margin requirements.
In summary, these setups are designed for different market expectations: the first for a bullish outlook, expecting the stock to not fall below the sold put strike; the second for a neutral market stance, capitalizing on range-bound trading; and the third for a bearish view, profiting if the stock price falls below the breakeven price. The premium received for the credit spreads represents the maximum gain, and the debit paid for the debit spread represents the maximum loss. The breakeven points are critical to identify the price level at which the trades break even at expiration. The margin impact and maximum risk need to be managed in accordance with the trader's risk tolerance and market assessment.
* Understanding these metrics is important for anyone involved in volatility-based trading strategies. The 'Expected Move' is an invaluable tool that provides a forecast of how much a stock's price might swing, positively or negatively, around its earnings announcement. This insight is essential for options traders, allowing them to gauge the potential risk and reward of their positions. Read more about it here: Understanding and calculating the expected move of a stock etf index
Moreover, the 'Implied Volatility Rank' (IVR) offers a snapshot of current volatility expectations in comparison to historical volatility over the last year. This ranking helps in identifying whether the market's current expectations are unusually high or low.
In addition to the Expected Move and Implied Volatility Rank, it’s also crucial to understand the concepts of ‘Implied Volatility’ and ‘Historical Volatility’. Implied Volatility (IV) is a measure of the market’s expectation of future volatility, derived from the prices of options on the stock. On the other hand, Historical Volatility (HV) measures the actual volatility of the stock in the past.
The relationship between these two types of volatility can serve as a valuable indicator for options traders. When IV is significantly higher than HV, it suggests that the market is expecting a larger price swing in the future, which could make options more expensive. Conversely, when IV is lower than HV, it could indicate that options are relatively cheap. Some traders use this IV-to-HV ratio as a signal for when to buy or sell options premium, adding another layer of sophistication to their trading strategies.
** A crucial application of the expected move in options trading is evident in strategies such as iron condors and strangles, particularly when these are implemented through short selling. In these strategies, the expected move serves as a pivotal benchmark for setting the boundaries of the trade. For instance, in the case of a short iron condor, traders typically position the short legs of the condor just outside the expected move range. This strategic placement enhances the probability of the stock price remaining within the range, thereby increasing the chances of the trade's success. Similarly, when setting up a short strangle, traders often choose strike prices that lie beyond the expected move. This ensures that the stock has to make a significantly larger move than the market anticipates to challenge the position, thus leveraging the expected move to mitigate risk and optimize the success rate. Utilizing the expected move in this manner allows traders to align their strategies with market expectations, fine-tuning their approach to volatility and price movements.
In this report, the calculation of the expected move for each stock and index is based on a refined approach, building upon the concepts outlined in our previous article. Traditionally, the expected move can be estimated by calculating the price of an at-the-money (ATM) straddle for the expiration date immediately following the event of interest. However, in this analysis, we've adopted a variation to enhance the accuracy of our predictions.
Our method involves a blend of 60% of the price of the ATM straddle and 40% of the price of a strangle that is one strike away from the ATM position. This hybrid approach allows us to closely mirror the expected move as indicated by the implied volatility (IV), offering a more nuanced and precise estimation. By utilizing this simplified yet effective method, we are able to provide an expected move calculation that not only resonates with the underlying market sentiments but also equips traders with a practical tool for their volatility-based strategies.
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