What Might Implied Volatility Be Saying? Listen to the Market Maker Move Indicator

If you’re an active trader, you know that volatility is like those bowls of porridge on the bears’ table—best when neither too hot nor too cold.

When trading short-term fluctuations, it’s hard to profit from a stock or option that doesn’t move. But an unexpected spike in implied volatility (IV) can also wreak havoc on a portfolio or a trading strategy. Traders can attempt to guard against this—and potentially use it to their advantage—by monitoring the Market Maker Move (MMM) feature on the thinkorswim platform from TD Ameritrade.

What Is the Market Maker Move?

As you may have guessed from the name, 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 implied volatility, creating an estimate of potential daily price movement.

Note that the MMM number 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 say that XYZ is trading at $100 and has an MMM number of ±10. This tells you 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 (such as 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. 

Sometimes It’s There; Sometimes It Isn’t. What Gives?

Much of the time, 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 an MMM, you’ll see it in thinkorswim under the Trade tab > All Products. MMM is shown on the same line as the symbol box, to the right of the bid and ask. 

No MMM? It simply 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 (see figure 1).  

The stock in figure 1 is trading at $216.88 and has an MMM number of ±16.74. This tells you the options market has priced in a move to as low as $200.14 and also to as high as $233.62.  

MMM can be a powerful tool if you’re trading in earnings season, if you’re an investor holding shares of a company that’s about to release earnings, or if there’s pending company news such as a new product release, potential merger/acquisition talks, or legal/regulatory action.

How to Use the Market Maker Move for Earnings

Trading around earnings can be tough, but MMM can help you determine which strategy you want to employ (if any). Here are a few ideas:

• 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. If your stock is trading at $216 and there’s an MMM number of ±5.4, you might be comfortable with an event risk of 2.5%. But look back at figure 1, in which the MMM is implying a potential 7.7% move. Is that a position worth holding in its entirety? That depends on the percentage of your overall portfolio composed of that stock and your overall risk tolerance.
• Picking points. Eyeing a a setup on your chart and trying to decide your entry or exit point? Check the MMM. It might add a level of validation to your entry point, profit target, or stop order level. But remember: If a stop order is triggered, it competes with other market orders. The MMM makes no guarantees.
• Choosing options strikes. The MMM can be particularly powerful when it comes to building an options strategy around earnings. For example, some option traders use an iron condor in an attempt to capitalize on the expected collapse of implied volatility—common after earnings are released and the market has its initial reaction. Such a trader might set strikes outside the MMM range. Or, if you wanted to put on a purely directional trade using a put or call, you could compare the at-the-money (ATM) options to the MMM number. For example, if the ATM options are trading for equal to or more than the MMM number, you would have a lower chance of profiting on the trade. But if the ATM is trading for less than the MMM number—implying a potentially larger move than is being priced in—it might be a trade worth considering.

The MMM can be a handy tool to help inform your trading. But in the end, it’s just a probabilistic measure: a “wisdom-of-the-crowd” consensus expectation of the potential magnitude (but not direction) of market movement. Nothing more. Still, it uses some of the same things professional market makers use to set their bid/ask spreads. That could be something worth following.