Research Summary
The report discusses the concept of ‘expected move’ in options trading, a new feature on the Deribit platform. It explains how the expected move is calculated using at-the-money (ATM) implied volatility and the current price of the underlying asset. The report also highlights the limitations of expected move calculations, emphasizing that they represent market views, not actual probabilities. It further provides a detailed guide on how to calculate the expected move and its application in trading.
Key Takeaways
Understanding the ‘Expected Move’
- Definition and Calculation: The ‘expected move’ in options trading refers to the anticipated size of price movements of an asset by a certain date. It is calculated using the current price of ATM options on the asset and the ATM implied volatility. The report provides detailed formulas for calculating the expected move.
- Application on Deribit: The Deribit platform now allows users to see the expected move on the option chain. Each expiry date has a different expected move, and the size of the expected move up or down can be seen in the header for each expiry date in the option chain.
Limitations of Expected Move Calculations
- Market Views, Not Actual Probabilities: Expected move calculations represent the market’s view, as expressed through the price of options. They provide insights into the distribution of possible prices but do not accurately predict future prices. The market’s view may not always prove accurate.
- Assumption of Lognormal Distribution: Expected move calculations assume that the future price is lognormally distributed, which may not always be the case. Despite this limitation, the expected move is a useful statistic as it provides a quick view of the market’s current expectations of price movements.
Calculating Up and Down Moves Separately
- Need for Separate Calculations: With higher volatilities or longer time to expiry, it becomes necessary to consider the likely size of the move in each direction separately. This is because the distribution of possible future prices is not symmetrical, and using a lognormal distribution eliminates the possibility of negative asset prices, providing a more realistic model.
Application of Expected Move in Trading
- Visualizing Likely Moves: The expected move feature on the Deribit option chain helps traders visualize likely possible moves for the underlying asset for each expiry date. This aids traders who base their options trading on where the strike price sits relative to likely moves in the underlying price.
Actionable Insights
- Utilize Expected Move Calculations: Traders can use the expected move calculations to gain insights into the market’s view of possible price movements. This can aid in making informed trading decisions.
- Consider Limitations: While using expected move calculations, traders should consider their limitations. They should remember that these calculations represent market views and not actual probabilities, and the future price may not always fall within the expected range.
- Apply Separate Calculations for Up and Down Moves: In cases of higher volatilities or longer time to expiry, traders should calculate the likely size of the move in each direction separately for a more realistic estimate of possible future prices.
