Stock move estimation on expiration day based on option prices

[caption id="attachment_387" align="aligncenter" width="500" caption="SPX move estimation based on option prices"][SPX move
estimation based on option prices][][/caption]

I'd like to document a useful technique I picked up today from Tom Sosnoff on ShadowTrader. It's based on the idea that option pricing has become so efficient that it can be used to predict actual stock move.

Since it is expiration Friday this week, the Oct 08 index option are expiring in two days. So for something like, SPX, the Oct 08 call/put has only two days left. Thus, there's little time decay factored in the price for these options with respect to the actual price. In other words, SPX and SPX options prices are converging.

So if we take the price of the straddle and strangle strike on the money, it should be the expected move for SPX for this Friday. For example, SPX closed at 907.84 today. The price for a straddle at 905 strike is \$48.65. The price for a strangle at 900/910 strikes is \$45.30. We'll average the two numbers (\$48.65 + \$45.30) / 2 = \$47.0.

So the SPX is expected to move about 50 points this Friday either up or down.

[SPX move estimation based on option prices]: http://traderpau.files.wordpress.com/2008/10/option_est1.jpg