Expected Move
Tesla (TSLA) reports earnings after the close. Options are pricing an almost 7% expected move in the stock this week.
With the stock near $740 that translates to a potential upwards move to around $790 and potential downwards move to around $690, which would erode all of April’s gains.
Whether an investor agrees with either the bullish or bearish consensus, or simply thinks the options market is over-pricing the move altogether, knowing the expected move can serve as a useful gut-check before any major catalyst event.
Below, we’ll explore further how the expected move might be utilized by option traders themselves. Particularly in helping guide strike selection in strategies that seek to reduce costs in higher priced stocks at a time of elevated volatility.
Call Alternatives
At the time of writing, buying 100 shares of stock would cost about $74k. Buying a weekly (Apr 23 expiry) $740 (at-the-money) Call costs around $28, or $2800 in premium. In order for the call to be profitable on Friday’s expiration, the stock would need to be above $768.
A slightly out-of-the-money call, the $750 for instance, lowers the cost slightly, to about $24. But buying that call would need the stock above $784.
Now, let’s take a scenario where a trader wants to position for a move higher but with a breakeven closer to where the stock is currently trading. The 7% expected move can help guide strike selection when creating a defined risk option spread. One that lowers the breakeven when compared to out-of-the-money or at-the-money calls outright.
Using the Options AI platform, we’ll look below at some alternative strategies that have been generated with the expected move guiding strike selection. We can start by directly comparing the at-the-money 740 call to a 740/785 call spread.
The 740/785 Debit Call Spread lowers the cost of buying the at-the-money call, from $28 to $17 by simultaneously selling a Call around the expected move level. In turn, this brings down the break-even level to around $757, vs $768 for the 740 call outright, while increasing the probability of profit from 36% to 42% The trader has also reduced their overall exposure to elevated volatility in the options versus an outright call. Less capital is at risk, and a lesser move higher is needed in order to at least breakeven.
Aside from the additional potential risks of option spreads (such as early assignment and liquidity), it is important to note that a spread caps potential profits (if the stock moves beyond $785). One way of looking at this is that the trader has joined the option market consensus with a view that the stock is less likely to move beyond 7% and therefore is willing to cap gains at that point.
Put Alternatives
If a trader is interested in positioning for a move lower in the stock, the bearish consensus can serve as a guide. Again, using the Options AI platform, with April 30th expiry:
Credit Spreads
Another way for a trader to express a view is by selling premium in the form of a credit spread. This trade typically risks more to make less, but instead of needing the stock to move in one direction or the other, it is profitable if the stock doesn’t move in the direction of the spread. It can be thought of as selling to those that are positioning for a move.
Below are examples of bullish credit put spreads based on the expected move with the stock trading near $740:
And bearish credit call spreads:
The out of the money credit spreads can even be combined to form an Iron Condor, a credit spread that looks to make money if the stock stays within the strikes based on the expected move:
Options AI puts the expected move at the heart of its trading platform. It allows traders to quickly surface and compare more ways to trade, either with trades based on the expected move, or through a more informed user price target in context of the expected move.
Options AI provides a couple of free tools like an expected move calculator, as well as an earnings calendar with expected moves. More education on expected moves and spread trading can be found at Learn / Options AI.
Based upon publicly available information derived from option prices at the time of publishing. Intended for informational and educational purposes only and is not any form of recommendation of a particular security, strategy or to open a brokerage account. Options price data and past performance data should not be construed as being indicative of future results and do not guarantee future results or returns. Options involve risk, including exposing investors to potentially significant losses and are therefore not suitable for all investors. Option spreads involve additional risks that should be fully understood prior to investing. Securities trading is offered through Options AI Financial, LLC a registered broker-dealer.
