Trading options involves predicting the underlying asset's price, and then you can choose the strategy that supports your prediction. This is especially true with options trading strategies like covered calls, which require you to own the underlying security - like a stock.
As a refresher, covered calls aim to generate income by selling call options on stocks you already own. This strategy works best when you expect the stock price not to exceed the call option's strike at expiration.
With the right market conditions, underlying assets, and strike price placement, you can theoretically write covered calls over and over, for as long as you own the stock. Doing so boosts profitability and lowers your cost base. The premium received acts as a cushion, softening the impact of minor price drops and provides investors a steady income stream.
However, there’s always a risk. When your price forecast goes the wrong way, your short call can get assigned, and you'll end up selling your underlying security. That’s the inherent difficulty of price prediction; we don’t have working crystal balls, and our best guesses are only that—guesses.
Still, there are ways to make educated guesses about the stock price's future. I’ll show you one right now.
Using Long Straddles For Price Prediction
A long straddle involves buying a call and a put option at identical strike prices, expecting the underlying price to move significantly in either direction. The move must be big enough to cover the cost of buying two long options; otherwise, the trade will not be profitable.
Based on how the strategy works, traders use the cost of a long straddle as a shorthand predictor of a stock’s expected price move through the 85% rule.
It works like this:
- Apple stock currently trades at $220.73
- An ATM Long straddle expiring May 16, 2025 with a $220 strike price costs $18.10
- 85% of $18.10 = $15.39
- Add $15.39 to the strike price to get the higher end of the range ($236.12)
- Subtract $15.39 from the strike price to get the lower end of the range ($205.34)
This strategy is called the "Expected Move" or Implied Move. As you can see, using 85% of a long straddle’s value shows the market’s relative expected price range of a stock within a given period.
How to Use Expected Move For Covered Calls
Expected Move can be used for covered calls. All you have to do is figure out your expiration date, calculate the values based on how much a long straddle with the same expiration date costs, and set your short call’s strike price above the higher end of the range.
However, time is money in trading, and not everyone has the time or desire to do the math and figure out the best strike to sell a covered call. To make things easier, Barchart has made Expected Move available in its Options features.
The range, as predicted by the Expected Move, can be used to target high and low prices and is especially useful around earnings season. The chart includes the stock’s price movement in the last six months and is followed by the Expected Move prices based on the next two weekly and monthly options contracts.
Practical Example
Let me show you how to use the Expected Move feature in your trading.
So, first, let’s assume you own 100 shares of AAPL stock and want to write covered calls on them. You can then go to the Expected Move, found on the left-hand navigation menu from Apple’s stock profile page.
Once there, scroll through the available expiration dates and find one suitable for your trading preferences. For example, you want to write a covered call with a 39-DTE expiring May 2, 2025.
AAPL stock is expected to move by 6.32% in either direction on that date, putting the higher price range at $234.67. This is your reference point for your strike price.
Then, go to the Covered Call screener page for Apple, also found on the left-hand menu.
Once there, change the Expiration Date dropdown to 5/02/25. You will be shown a selection of strike prices and other relevant trading information like premium prices, delta, OTM probabilities, and more.
Using the $234.67 high price reference point, you can start looking at selling a $235-strike covered call, to give yourself the best chance of avoiding assignment while collecting the highest premium.
If you look at the OTM Prob column, you can also see that covered calls at and above the $235 strike price have a high probability of expiring out of the money.
Of course, how close you want to trade to the $234.67 reference high price range is up to you. There’s also nothing stopping you from selling covered calls above or below that strike price, though you might want to review the OTM probabilities first.
This practical example is not the only way to use the Expected Moves feature. You can apply this to any of your trades at any point and in any way you prefer, including:
- Quickly gauging volatility before earnings
- Selecting strike prices for covered calls
- Establishing realistic profit targets
- Identifying optimal credit spread ranges
- Evaluating risk/reward for directional trades
Final Thoughts
The Expected Move feature can be a great addition to your trading strategy. The estimated price range helps you set realistic price and profit targets for your trades, improving your risk management. Though not 100% fool-proof, the tool still enhances your chances of profiting from your trades, be it covered calls or any other options trading strategy.
However, this isn’t a substitute for due diligence and trade monitoring. Always keep an eye on your trades to mitigate assignment risk, set take-profit and cut-loss prices, and adjust your strategy as market conditions change.
