When trading short-term fluctuations, it can be difficult to profit from a stock or option that doesn't move. But an unexpected spike in implied volatility (IV)1 can also potentially wreak havoc on a portfolio or trading strategy. Traders can attempt to guard against this—and potentially use it to their advantage—by monitoring the Market Maker Move™ (MMM) indicator on the thinkorswim® platform.
What is the Market Maker Move?
The Market Maker Move (MMM) uses some of the same inputs that market makers do, such as stock price, volatility differential, and time to expiration. A proprietary calculation then reverse-engineers the options pricing model based on assumptions about IV, creating an estimate of potential daily price movement.
Note that the MMM value does not guarantee a stock will move by a certain magnitude, nor does it indicate in which direction a move might occur. It only means the options market has priced in an expected move—up or down—over and above that of a typical trading day.
Let's look at an example. Say XYZ is trading at $100 and has an MMM of ±10. This tells the trader the options market has priced in a $10 move, whether as low as $90 or as high as $110, in light of an upcoming event like earnings. Of course, there are no guarantees. The actual move could be more or less, up or down, or there could be no reaction at all.
What if there isn't a MMM value?
In many instances, there's no MMM value present. It shows up only when "excess volatility" is detected. Typically, that means the IV in the current-week options expiration is higher than that of the next expiration date.
If there's currently a MMM, you'll see it on thinkorswim under the Trade tab > All Products. The MMM is shown on the same line as the symbol box, to the right of the bid and ask.
If MMM isn't showing up on the screen, it means the options market isn't pricing in any excess volatility. In normal markets, IV is lower in the front-month options contract than it is in deferred months. When the market is pricing in a potentially outsize move, such as right before an earnings release or other company announcement, front-month IV might be higher. That's when you'll see the MMM displayed as shown in the image below.
Source: thinkorswim® platform
The image above shows a stock trading at $216.88 with an MMM of ±16.74. This tells a trader the options market has priced in a move to as low as $200.14 and as high as $233.62.
The MMM can be a powerful tool for traders during events like:
- Earnings season, especially when holding shares of a company that's about to report
- Pending company news, such as a new product release, potential merger/acquisition talks, or legal/regulatory action
How to use the MMM for earnings
When trading around earnings, there are some strategies that can be used with the help of the MMM:
- Risk budgeting. Suppose you have an existing position going into earnings. Checking the MMM might be a good way to decide if it's worth the risk to hold through the event. For example, if your stock is trading at $216 and there's a MMM of ±5.4, you might be comfortable with an event risk of 2.5%. The image above, though, shows MMM is implying a potential 7.7% move. Whether you want to hold in this situation depends on your overall risk tolerance. You might decide that holding this position doesn't work for you if a risk event does materialize.
- Picking points. When reviewing your chart and trying to decide your entry or exit point, the MMM might add a level of possible validation to your entry point, profit target, or stop order level. Remember, though, if a stop order is triggered, it competes with other market orders.
- Choosing options strikes. Some option traders might use an iron condor2 in an attempt to capitalize on the expected collapse of IV that often comes after the market's initial reaction to earnings releases. In this instance, a trader might set strikes outside the MMM range. Or, if a trader wanted to put on a purely directional trade using a put or call, they could compare the at-the-money (ATM) options to the MMM. For example, if the ATM options are trading equal to or more than the MMM, they'd have a lower chance of profiting on the trade. But if the ATM is trading for less than the MMM—implying a potentially larger move than is being priced in—it might be a trade worth considering.
The MMM can be a helpful tool to inform a trader's strategy. However, it's important to remember it's a probabilistic measure that reflects the expectation of the potential magnitude (but not direction) of market movement. Even so, it can be a data point that helps traders make more informed trading decisions.
1The market's perception of the future volatility of the underlying security directly reflected in the options premium. Implied volatility is an annualized number expressed as a percentage (such as 25%), is forward-looking, and can change.
2A defined-risk short spread strategy constructed of a short put vertical and a short call vertical. You assume the underlying will stay within a certain range (between the strikes of the short options). The goal: As time passes and/or volatility drops, the spreads can be bought back for less than the credit taken in or expire worthless, resulting in a profit. The risk is typically limited to the largest difference between the adjacent and long strikes minus the total credit received.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled "Characteristics and Risks of Standardized Options" before considering any options transaction. Call Schwab at 800-435-4000 for a current copy. Supporting documentation for any claims or statistical information is available upon request.
Spread trading must be done in a margin account. Multiple leg options strategies will involve multiple commissions.
With long options, investors may lose 100% of funds invested.
Probability analysis results from the Market Maker Move indicator are theoretical in nature, not guaranteed, and do not reflect any degree of certainty of an event occurring.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Investing involves risks, including loss of principal.0523-3GU1