How to calculate an expected range for the market?

Last Updated: 6 Jun 2023

Information about expected monthly range can be used by people who trade in derivative markets, especially the options traders as Implied volatility can be used to calculate the upper and a lower range of an underline derivative security. Option writers can use this expected monthly range to short the options above or below the expected monthly range, while Plain-Vanilla option buyers can use this upper and lower range to create spread positions i.e. Bull-Call spread, Bear-Put spread, Ratio spread etc in order to reduce their entry-level cost on their Plain-Vanilla positions.

What is IV?

Implied volatility (commonly referred to as volatility or IV) is determined by the current price of options contracts on a particular stock. Implied Volatility of an option contract is the volatility implied by the market price of an option based on an option pricing model. IV has a direct relation to the option premium, higher the IV, higher the option price.

How to calculate?

Since IV is a Standard Deviation. So, for a 1month range calculation:

Range calculation formula:

Expected Movement= Current market price* IV * Square root of (Days left to the expiry/Days in a year)

Expected Movement = 10226 (Nifty November expiry level)

*12%(Nifty IV level)*Square root of (28/365 ), which is 339.8 Points.

So we can expect a movement of +/- 340 points from the current level for the Nifty index in the mo8nth of December. An expected upper range will be 10566 and lower range will be 9886.

Remarks:

As per IV calculation, the NIFTY range for December is 10566 to 9886.

Range calculation success ratio with the help of IV until November is 8:3 i.e (Out of 11 months in 2017, only 3-months have seen an expiry above or below calculated range)