Stocks can move dramatically in an earnings season, which may offer potential trading opportunities. However, they can also lead to a rapid fall in prices, so investors should be aware of this risk.
But how much will a stock move after it reports earnings?
Investors or traders may use a helpful tool called "expected move" to make earnings estimations.
01 What is the expected move
The expected move is the amount a stock is expected to increase or decrease from its current price, based on its current options prices.
It can provide insight into the expected price range for a stock or ETF in its options market for a specific period.
Calculating expected moves can help spot potential opportunities and risks, particularly around big events like earnings, economic indicators releases, or FDA announcements.
02 Calculating expected move
A simple way to calculate the expected move is to use 85% of the value of an at-the-money long straddle. [1]
Long straddles are designed to profit from an increase in implied volatility by purchasing call and put options with the same strike price and expiration date.
Therefore, the price of an at-the-money straddle can indicate the underlying stock's implied volatility.
Simply put, when calculating the expected move of a stock for the earnings week, you can consider exploring the following approach:
● Choose the first expiry date after the earnings date.
● Look up the option chain and add the price of the at-the-money call option and that of the at-the-money put option.
● Then multiply that value by 85% to get the expected moves. You can translate the results into percentage terms by dividing them by the stock's current price.
Remember, the expected move is only the expected fluctuation range of the stock price. In other words, this is a move that could be either up or down from the current price.
[1] Source: Options AI Support
03 Example
Let's look at an example of using the at-the-money straddle to calculate expected moves.
Suppose Apple is trading at US$135 two days ahead of its earnings announcement on February 2.
The earliest Apple stock option's expiry date is February 3.
Assume that the US$135 call option is trading around US$4.5 and the US$135 put option is trading at US$4.1.
The total premium of the two options is US$8.6. Multiply it by 85% and you'll get an expected move of US$7.31.
It indicates that the options market thinks Apple stock could move up or down by US$7.31 between now and February 3.
That translates to roughly a 5.4% (US$7.31/US$135) move either way.
It is worth noting that the market is constantly changing. So the stock may not necessarily rise or fall the exactly same amount as expected in the future.
04 What are some factors to consider?
Knowing the market expectations of a stock's movement before a future date (expiration date) might help traders in the following ways.
● If you have profitable positions, knowing the expected move might help you make more informed hold-or-exit decisions.
● The expected move can help manage risks and act as a hedging tool before big events like earnings, economic indicators releases, or FDA announcements.
Additional Disclaimer:
Opening new options positions close to or on their expiration date comes with a substantial risk of losses for reasons that include potential volatility of the underlying security and limited time to expiration. Any illustrations, scenarios, or specific securities referenced herein are strictly for educational and illustrative purposes and are not a recommendation or endorsement of any particular investment or investment strategy.