I am new to options trading and want to know about the expected move or percentage change derived by IV, the probability of the underlying moving by 68%, perhaps the max EM is +10, does it mean that at the end of a givin time frame it will land at +10 at max movement, or will it potentialy temporarly exceed the max move and will converge at the end of the time frame at around +10 points? Or does it mean that the probobility of even exceeding the max move temporarly is 32%.
Thank you.
Posted by saoeifjasasef2
3 Comments
Is EM short for expected move? If you’re looking for the over/under for an underlying expected move, looking at the at the money straddle prices will give you a much better feel than IV. Straddle price is basically IV in dollar terms, and since you trade in dollars and market moves in dollars, it’s much more intuitive
The expected move is the range that the closing price is expected to close into. So if the expected move is 10 points for the next week, then the expected move is telling you that there is a 68% chance the stock will close the week somewhere between plus or minus 10 points.
Options are priced assuming a certain distribution of possible outcomes. In a model like black scholes, it assumes a lognormal distribution, or normal distribution of returns. The IV shown is always in annualized terms. It represents the 1 standard deviation expected move annualized. So in a one year option with an IV of 30%, it’s pricing in a 65% chance that the underlying is +/- 30% in one year. You can use this basic premise to look at different time frames. Since volatility is proportional to the square root of time, you can get to a daily implied 1SD move by diving by sqrt(252). It just gives you an idea of what the distribution looks like based solely on that specific option. Obviously true returns are not perfectly normal and have much fatter tails than that distribution would imply. That is one of many reasons that a vol smile exists, but that’s a topic for another time.