Using Options to Predict Stock Prices

how to predict stock prices with options dataWhat if you had a way to predict stock prices?

You can actually use an options technique for stock price prediction. In this article, we explore how to use this powerful technique as we create a plan of action for a trade we want to make. This technique makes use of data available for options trading, but in this case, we are not trading options. Instead, we will use the options data to our advantage in setting up a stock trade.

This technique is quick and simple. It will provide us with information that is crucial for planning a successful stock trade. Since it is simply based on free information, it makes sense for every trader to take advantage of this technique to predict stock prices with a higher level of probability.

Two Crucial Questions for Planning a Stock Trade

Suppose we’ve identified a stock that is poised to make a move up or down, and we want to set up a trade for that stock. We have an expectation that the stock will move, but to set up the trade, first we need to fill in a few more details. In particular, we want a forecast that answers two questions:

  1. How much could the stock price rise (or fall)?
  2. What is the time frame for that expected rise (or fall)?

To answers these two questions, we can forecast for the expected move of the stock. The expected move is a specific prediction that the stock price could rise or fall a certain number of dollars within a certain number of days.

Having this expected move will help to create a trade with a higher probability of success. Increasing probabilities is at the core of all successful trading and trading is a business of probabilities.

The answers to these questions will guide us in creating our plan of action for the trade. Once we have a specific prediction for the expected move of the stock, we can choose our profit stops and stop loss for the trade setup.

The Options Technique

There are a few ways to go about finding answers to these two questions to help predict the stock price move and time frame. One approach is to use Fibonacci levels. Another good way, the one we discuss in this article, is to use options data. The advantage of this technique is that it is quick and easy to apply.

When we use and compare these two methods for stock price prediction, Fibonacci and option data, and they align, I like to call this “Double Confirmation”. Sometimes, they don’t align, but when they do, we know we have an even more reliable price prediction.

To use options to predict a stock’s prices, the key is to look at the straddle costs for the various option dates in the stock’s option chain. Let’s walk through an example to see how it works.

Example using NVDA Stock

Suppose we have picked NVIDIA Corp. (NVDA) as a stock with good potential for making a price move upward in the near future. For the purposes of this demonstration, today is March 14. Here we see the daily chart for NVDA, showing about seven months of its price history:

NDVA daily chart

Note: All Images Created Using ThinkorSwim Platform

The chart shows high and low Fibonacci levels from November. Maybe we have chosen this stock on the basis of those Fibonacci levels, or maybe it was some other indicator we used, but we’ve chosen this stock to see if it looks like a high probability trade.

Now we want to move ahead and set up a trade on this stock. So first we’ll make a specific prediction for the expected move of the stock, and for this, we’ll use the options technique.

How to Read the Options Data

We go to the option chain for NVDA. You can get this same information from most brokerage platforms for free, so it’s smart to use it to your advantage before placing trades. Here is how it looks on the ThinkorSwim platform:

NVDA option chain (ThinkorSwim platform)

Down the left, we see the list of expiration dates for the options in the series. Let’s take a closer look:

List of options for NVDA, showing expiration dates along with the number of days away in parentheses

Just after each expiration date, in parentheses we see the number of days from today’s date (March 14) to the expiration date. For example, we see March 15, which is 1 day away; March 22, which is 8 days away; March 29, which is 15 days away; and so on down the list.

Off to the right on the option chain screen, the number in parentheses is the straddle cost associated with that option. Here is a close-up view:

NVDA straddle costs (in parentheses) for the list of options in the option chain

The straddle cost gives us an indication of the market’s expectation of how much the stock price could rise or fall by that expiration date. For example, the third line down (outlined in yellow) corresponds to the March 29 option (15 days away). There we see a straddle cost of ±10.916, or about $11. This tells us that the price has the potential to move up $11 or down $11 by March 29.

How to Interpret the Options Data for Stock Price Prediction

At the top of the screen, it tells us that the current price for NVDA is 167.06, or about $167.

Current stock price for NVDA (outlined in yellow)

So, based on the straddle cost of $11 for March 29, a reasonable expectation for the price movement within 15 days is that it could go up to about $178 ($167 plus $11) or down to about $156 ($167 minus $11).

A 2nd Confirmation for Stock Price Prediction

As a bonus, we notice that the top of the range of the potential price movement, $178, is close to the value of a Fibonacci level that we had established earlier ($177.91).

NVDA Fibonacci levels

The close alignment of these two values is a good sign that our price expectation is a realistic one.

The 2 Crucial Answers to Help Predict Stock Prices

So, using the options technique, we have found the answers we needed to the two crucial questions mentioned at the beginning of the article. These provide us with a specific prediction for the expected move of the NVIDIA stock price: $11 within 15 days. This will be our basis for setting profit stops and a stop loss for the trade, and we will then have a sound plan of action and can proceed with the trade.

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Sources: Images Courtesy of ThinkorSwim and T.D. Ameritrade

Larry Gaines - Options Trading - Bio

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