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Volatility report - week 05 - a magnificent week (5/7)

Options 10 minutes to read
Koen Hoorelbeke

Investment and Options Strategist

Summary:  Our weekly Volatility Report includes a list of expected price movements, implied volatility rankings for upcoming earnings, key indices, and ETFs. In this edition we also have a look at some possible trade setups for a selection of those stocks.

Volatility report - week05
(Jan 29 - Feb 2, '24)

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 stocks in the list.

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.

 

Suggestions? Ideas? Let us know!

Expected moves and volatility

Volatility and Expected Moves Analysis

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:

  • Volatility Comparison: Implied volatility (IV) is currently contrasted against the 30-day historical figure to assess market expectations. A significant disparity often marks a prime scenario for premium selling.
  • IV Rank Insights: IV Rank situates the current IV within the past year's range. Values above 20% generally signal higher-than-average volatility, favoring premium selling, while lower values suggest caution for such strategies.
  • Sector Highlights: Financial firms, including Morgan Stanley and Goldman Sachs, are poised to report, with anticipated modest price movements. In contrast, larger expected moves for tech companies like Microsoft and Netflix indicate market anticipation of their earnings results.
  • Strategic Considerations: For traders, higher expected moves in the tech sector suggest the potential for volatility strategies, while lower moves in financials may align with range-bound positions.
  • Upcoming Economic Data: Key releases, particularly Retail Sales and Initial Jobless Claims, may introduce additional market volatility, reinforcing the value of expected move and IV in strategy development.
  • Highlighted Stocks:

    The list contains 5 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/premium selling 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.

Microsoft (MSFT)

  1. Bullish Trade Setup (Credit Put Spread)

    • This is a credit put spread (also known as a bull put spread), where the trader sells a higher strike put and buys a lower strike put with the same expiration date. In this case, the trader is selling the 400 put and buying the 395 put for the 15-Mar-2024 expiration. The net credit received is $140 (premium of the sold put minus the premium of the bought put).
    • The maximum profit is limited to the premium received, which is $140. The maximum risk is the difference between the strikes minus the premium received, which amounts to $360.
    • The breakeven point at expiration would be the higher strike price (400) minus the net premium received ($1.40), so $398.60.
    • This trade will be profitable as long as MSFT stays above the breakeven price at expiration. The trader is moderately bullish and expects MSFT to not drop below $400 by the expiration date.

  2. Neutral Trade Setup (Iron Condor)

    • The second setup is an iron condor, which involves selling a call spread and a put spread. This strategy is typically used when the trader expects the stock to trade within a certain range. The specific strikes chosen are the 435/430 call spread and the 390/385 put spread.
    • The net credit received for this setup is $255, which is the maximum potential profit. The risk is the difference in the strike prices of either the call spread or the put spread (whichever is greater) minus the premium received. Since both spreads are $5 wide, the maximum risk is $245.
    • The breakeven points are found by adding and subtracting the net premium received from the sold call and put strikes. So, the upper breakeven would be 430 + $2.55 = $432.55, and the lower breakeven would be 390 - $2.55 = $387.45.
    • This trade will be profitable if MSFT stays between the breakeven points by expiration. The trader expects the stock to stay within a range and is capitalizing on time decay.

  3. Bearish Trade Setup (Credit Call Spread):

    • This strategy involves selling a lower strike call (420) and buying a higher strike call (425), which is bearish as it profits if MSFT stays below $420.
    • The net credit received is $225.00 USD, which is the maximum profit, kept if MSFT remains below $420.
    • The maximum risk is the difference in strike prices minus the credit received, which is $275.00 USD.
    • The breakeven point would be $422.25 (the sold call strike plus the credit received per share).

Alphabet (GOOGL)

  1. Bullish Trade Setup (Credit Put Spread)

    • This trade is a credit put spread where the trader sells a put with a higher strike price (150) and buys a put with a lower strike price (145), both expiring on 15-Mar-2024.
    • The trader receives a credit (premium) of $151, which is the most they can earn on this trade. The maximum risk or potential loss is the difference between the strikes minus the premium received, which is $349 ($500 - $151).
    • The breakeven point is $148.49 (the higher strike of 150 minus the premium of 1.51 received).

  2. Neutral Trade Setup (Iron Condor)

    • The second setup is an iron condor, which combines selling a call spread (175/170) and a put spread (140/135). It’s used when the trader expects the stock to stay within a specific price range.
    • The trader gets a net credit of $121, which represents the maximum potential profit. The maximum risk is $379, calculated as the difference in strike prices of the spreads ($500) minus the premium received ($121).
    • The breakeven points are $138.79 for the lower side (140 - 1.21) and $176.21 for the upper side (175 + 1.21).

  3. Bearish Trade Setup (Credit Call Spread)

    • A credit call spread here involves selling a call at a lower strike price (165) and buying a call at a higher strike price (170).
    • The net credit received is $153.00 USD, which is the maximum profit, kept if GOOGL remains below $165.
    • The maximum risk is the difference in the strike prices ($500) minus the credit received, which is $347.00 USD.
    • The breakeven point would be $166.53 (the sold call strike plus the credit received per share)

Apple (AAPL)

  1. Bullish Trade Setup (Credit Put Spread)

    • This is a credit put spread where the trader is selling a put with a higher strike price (185) and buying a put with a lower strike price (180) with both options expiring on 15-Mar-2024.
    • The trader receives a premium of $115 for this trade, which is the maximum profit potential if AAPL stays above $185 by expiration.
    • The maximum risk is the difference between the strikes ($5) minus the premium received ($1.15), which is $385.
    • The breakeven point would be the higher strike (185) minus the premium received ($1.15), so $183.85.

  2. Neutral Trade Setup (Iron Condor)

    • This setup is an iron condor involving selling a call spread (210/205) and a put spread (180/175). The strategy is designed for when the trader expects the stock price to stay within a specific range.
    • The trader receives a net credit of $150, which is the maximum profit if AAPL stays between the strikes of the sold options (205 and 180) by expiration.
    • The maximum risk is the difference between the strikes of the spreads ($5) minus the premium received ($1.50), totaling $350.
    • The breakeven points would be $178.50 on the lower side and $206.50 on the upper side, calculated by adjusting the sold strikes with the premium received.

  3. Bearish Trade Setup (Credit Call Spread)

    • This setup involves selling a 200 call and buying a 205 call, indicating a bearish position.
    • The net credit received is $190.00, which is the maximum profit if AAPL stays below $200 by expiration.
    • The maximum risk is the difference between strikes minus the credit received, which is $310.00.
    • The breakeven price is $201.90 (the sold call strike plus the credit received).

Amazon (AMZN)

  1. Bullish Trade Setup (Credit Put Spread)

    • The trader is setting up a credit put spread by selling a put with a higher strike price (155) and buying a put with a lower strike price (150), both with the same expiration date of 15-Mar-2024.
    • A net premium of $155 is received, which is the maximum profit possible on this trade, achievable if AMZN stays above $155 by expiration.
    • The maximum risk is the difference between the strike prices ($500) minus the net premium received ($155), totaling $345.
    • The breakeven point would be $153.45 (the sold put strike of 155 minus the premium of 1.55 per share).

  2. Neutral Trade Setup (Iron Condor)

    • The iron condor involves selling a call spread (185/180) and a put spread (150/145), a strategy that profits if the stock price stays within the strikes of the sold options by expiration.
    • The trader collects a net premium of $173, which is the maximum profit if AMZN trades between $180 and $150 by expiration.
    • The maximum risk is the difference between the strikes of the spreads ($500) minus the net premium received ($173), which is $327.
    • The breakeven points would be $148.27 on the lower side and $181.73 on the upper side, calculated by adjusting the sold strikes with the premium received.

  3. Bearish Trade Setup (Credit Call Spread)

    • In this bearish credit call spread, the trader sells a lower strike call (165) and buys a higher strike call (170).
    • The trader receives a credit of $190.00 USD, which is the maximum profit if AMZN stays below $165 by expiration.
    • The maximum risk is the difference between the strike prices ($500) minus the credit received, which is $310.00 USD.
    • The breakeven price is $166.90 (the sold call strike plus the credit received per share).

Meta (META)

  1. Bullish Trade Setup (Credit Put Spread):

    • This is a credit put spread where the trader has sold a put with a higher strike price (395) and bought a put with a lower strike price (390), both expiring on 15-Mar-2024.
    • The trader receives a net premium of $190, which is the maximum profit for this trade. This profit is realized if META stays above $395 by expiration.
    • The maximum risk is the difference between the strikes ($5) minus the premium received ($1.90), which totals $310.
    • The breakeven point at expiration would be $393.10 (the sold put strike minus the premium received).

  2. Neutral Trade Setup (Iron Condor):

    • The iron condor is constructed by selling a call spread (455/450) and a put spread (365/360), expecting the stock to trade within these bounds.
    • The net premium received is $195, representing the maximum potential profit if META stays between $450 and $365 at expiration.
    • The maximum risk is calculated as the difference between the strikes of the call or put spread ($5) minus the premium received ($1.95), totaling $305.
    • The breakeven points are $363.05 on the downside (365 - 1.95) and $451.95 on the upside (455 - 1.95).

  3. Bearish Trade Setup (Credit Call Spread):

    • This setup is a credit call spread, where a call at a lower strike (420) is sold, and a call at a higher strike (425) is bought.
    • The net credit received is $190.00, which is the maximum profit if META stays below $420 by expiration.
    • The maximum risk is $310.00, which is the spread between the strikes ($500) minus the credit received.
    • The breakeven price would be $421.90 (the sold call strike plus the credit received per share).

* 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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Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.

This article may or may not have been enriched with the support of advanced AI technology, including OpenAI's ChatGPT and/or other similar platforms. The initial setup, research and final proofing are done by the author.

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