The Most Accurate Price Target Calculation I Know
Target selection is an important part of any trading strategy. You need to be smart about where you plan on exiting your positions.
Developing these targets is harder than it sounds. Most traders don’t have a systematic method for doing so.
There are many approaches for developing these targets, but many of them rely on technical analysis and charting.
While these methods can work for some, I have always relied on the options market to develop solid price targets based on movement expectations priced into the market.
This might sound like a complicated calculation, but it’s actually incredibly easy to do.
Below I show you how to use the options market (even if you never trade options) to develop smarter and more accurate price targets for your trading plan.
Using the “At the Money Straddle” to Calculate Targets
To calculate a price target using the options market, you’re going to use something called the “at the money straddle.”
A straddle is an options strategy that involves buying a call and a put of the same strike price simultaneously.
What makes it an “at the money” straddle is when you select strike prices closest to the current price of the underlying stock.
You would run this strategy when you are expecting a large move in the underlying market but are unsure about the direction of that move.
Generally I avoid this setup because it involves a large amount of risk for a relatively small reward potential…
But in this case, we’ll use the price of the position to calculate an upside and downside target for the underlying stock.
Why Does This Work?
The reason we can use the straddle to calculate expectations is because the price of the trade represents the market maker’s expectation for movement by expiration.
If the market maker is willing to sell the at the money straddle for $10, that means they expect the stock to move $10 higher or lower by expiration.
That might sound confusing… but it’s not difficult to understand.
Let’s look at an example.
Example: Stock XYZ is trading at $100
The February $100 strike straddle is trading for $7.50 per contract (the sum of the 100 strike call and put prices)
You can now use this price to calculate the market makers implied closes for February options expiry.
This is the level they expect the stock to be at on the close on February 16.
Upside Target = Strike Price + Straddle Price = 100 + $7.50 = $107.50
Downside Target = Strike Price – Straddle Price = 100 – $7.50 = $92.50
You can now use these targets to inform your other trading strategies in the options market or in the underlying stock itself.
You don’t need to be an options trader to use this calculation and you can use straddle prices to get these targets in any security that has options.
If you’re more concerned with shorter term expectations, simply use a shorter dated option expiry.
The important thing to remember is that this is the target implied for the day of expiration, so be sure to keep that in mind.
Other Uses of This Strategy
This calculation is also helpful when you’re trying to select strike prices for options spreads or determining the expected move ahead of a catalyst event.
For those that don’t trade options, this is still a very useful tool to better inform target section.
Feel free to use this in combination with your technical analysis methods to develop smart, well thought out exit points for all of your trades.
AKA, “The Alpha Shark”