Using the Options Market to Create Stock Targets
How do you develop your exit targets? Odds are you use some kind of technical analysis method or just pick levels that “sound good” for an exit.
While using the charts to develop an exit plan is a totally valid approach there are better ways you can go about this.
I have always used the options market to calculate what the expected move in stock is.
I do this by using an options strategy called the at-the-money straddle. You can use this method to get a target for any stock or asset that has options.
Don’t worry if the name sounds complicated. It’s not…
Let’s go over the simple process for using straddle prices to calculate targets you can use for your own trade steups.
What is a Straddle?
A straddle is an options strategy that involves buying a call and a put option at the same time with the same strike price.
For example, if stock XYZ is trading at $100 you can buy the June 100 calls and June 100 puts at the same time to create the straddle.
“At the money” simply refers to the strike price closest to the stock’s current price.
In options trading this strategy is used to make both a bullish and bearish bet on a stock simultaneously.
You would do this when you expect a large move in the underlying stock but are unsure about the direction of the move.
For this exercise we will simply use the price of this spread to calculate an upside and downside target in the stock that you can use for other purposes.
Using the Straddle for Targets
When you are trying to develop an expected target for a stock you will take the price of the at the money straddle and the current stock’s price to do a quick calculation.
Example: Stock XYZ is trading at $100
The XYZ Jun 100 calls are trading at $2.00
The XYZ Jun 100 puts are trading at $3.00
In this example the price of the straddle is $5.00 (price of the calls plus the price of the puts).
This tells us that the options market is expecting a move of 5% higher or lower by June expiration.
You know this because the price of the straddle is 5% of the price of the stock ($5/$100).
To calculate actual upside and downside targets all you need to do is add and subtract the straddle price from the stock price.
Upside Target: $100 + $5 = $105
Downside Target: $100 – $5 = $95
You can now use these levels in other trade setups.
One important thing to note is that this is the market expected move by expiration. In our example, that’s the June expiration.
If you want to get an idea of what the expected move is in a shorter or longer time frame then simply use a different option expiry.
I’ve always used this trick on the trading floor and it’s a great way to help you develop expectations for a stock or any other asset with options.
You Don’t Have to Be an Options Trader
You don’t need to be an options trader to take advantage of this tip.
I know a lot of stock traders who use this method as a starting point for target development and never touch the actual options.
This method works well because it is using the real time prices and expectations of market participants to develop targets. Make this part of your toolbox today and you’ll be glad you did!
AKA, “The Alpha Shark”