Average True Range

Average True Range (ATR) is a volatility indicator that measures the average price movement over a specified period, appearing as a single line in a lower indicator panel below the price chart. Unlike implied volatility which shows market expectations, ATR reveals actual historical price movement, making it invaluable for setting realistic strike prices and stop losses. For option traders, ATR provides a concrete framework for position sizing and strike selection – if a stock typically moves $2 per day, selling strikes within that range invites assignment while placing them beyond provides a statistical edge. Understanding ATR helps option sellers avoid the common mistake of choosing strikes based on premium alone rather than probability.

How ATR Works

ATR measures the true range of price movement:

True Range Calculation

True Range is the greatest of:

  1. Current high minus current low
  2. Current high minus previous close (gap up)
  3. Current low minus previous close (gap down)

This captures gaps and overnight moves.

ATR Calculation

  • Average the True Range over N periods (typically 14)
  • Expressed in dollar terms, not percentage
  • Smooths out single-day spikes
  • Updates with each new bar

The result shows typical price movement magnitude.

Reading ATR Values

This lower indicator provides context:

ATR Interpretation

Stock at $50 with $1.50 ATR:

  • Typical daily movement: $1.50
  • Normal range: $48.50 to $51.50
  • 1 ATR move = normal day
  • 2 ATR move = significant day
  • 3 ATR move = unusual event

Higher ATR = more volatile stock.

Relative ATR

Compare ATR to stock price:

  • $1 ATR on $20 stock: 5% daily movement (high)
  • $1 ATR on $100 stock: 1% daily movement (low)
  • Use percentage: ATR / Price × 100
  • Allows cross-stock comparison

ATR for Strike Selection

Critical application for option sellers:

The 1-2 ATR Rule

Conservative (1 ATR):

  • Stock: $100, ATR: $2
  • Sell puts at $98 or below
  • Sell calls at $102 or above
  • ~68% probability OTM

Moderate (1.5 ATR):

  • Sell puts at $97 or below
  • Sell calls at $103 or above
  • ~80% probability OTM

Safe (2 ATR):

  • Sell puts at $96 or below
  • Sell calls at $104 or above
  • ~95% probability OTM

Weekly Options Adjustment

For 5-day expiration:

  • Weekly ATR ≈ Daily ATR × 2.2
  • Not 5× because volatility clusters
  • Adjust strikes accordingly

Example: Daily ATR: $1.50 Weekly expected: $3.30 Sell strikes beyond this range.

ATR Position Sizing

Using ATR for risk management:

Equal Risk Method

Normalize position sizes by volatility:

  • Stock A: $50 price, $1 ATR = 2%
  • Stock B: $100 price, $3 ATR = 3%
  • Allocate less to Stock B
  • Equal dollar risk per position

ATR-Based Allocation

$50,000 account example:

  • Risk 1% per trade = $500
  • Stock with $2 ATR
  • 2 ATR stop = $4 risk per share
  • Position size: $500 / $4 = 125 shares
  • Or 1.25 option contracts

ATR and Market Conditions

This lower indicator reveals market character:

Expanding ATR

  • Volatility increasing
  • Larger daily swings
  • Option premiums rising
  • Opportunities for sellers

Trading Approach:

  • Widen strike selection
  • Reduce position sizes
  • Take profits quicker
  • Expect larger moves

Contracting ATR

  • Volatility decreasing
  • Smaller daily ranges
  • Option premiums falling
  • Challenging for income

Trading Approach:

  • Move strikes closer
  • Increase position sizes
  • Hold for more decay
  • Prepare for expansion

ATR Patterns

Recognizing volatility cycles:

ATR Squeeze

When ATR reaches multi-month lows:

  • Big move imminent
  • Direction unknown
  • Consider buying options
  • Or wait for breakout

ATR Explosion

When ATR spikes suddenly:

  • Major event occurred
  • Reassess all positions
  • Widen strikes immediately
  • Reduce size

Seasonal ATR

  • Summer: Often lower ATR
  • Earnings season: Higher ATR
  • Year-end: Declining ATR
  • Plan strategies accordingly

ATR Stop Losses

Protecting option positions:

Stock Stop Loss

For assigned shares:

  • Entry at $50
  • ATR: $1.50
  • 2 ATR stop: $47
  • Logical, not arbitrary

Option Stop Loss

For sold options:

  • Sold put for $1.00
  • Stop at 2× premium = $2.00
  • Or use 2 ATR stock move
  • Systematic approach

Combining ATR with Greeks

Enhancing option strategies:

ATR and Delta

  • 1 ATR strike ≈ 0.30 delta
  • 2 ATR strike ≈ 0.15 delta
  • Confirms strike selection
  • Cross-validation tool

ATR and Implied Volatility

Compare ATR to IV:

  • ATR shows actual movement
  • IV shows expected movement
  • If IV >> ATR: Sell premium
  • If IV << ATR: Buy premium

Common ATR Mistakes

Using Fixed Numbers: ATR changes over time Ignoring Gaps: True Range captures gaps Wrong Timeframe: Daily ATR for monthly options No Adjustment: Same approach all conditions

Building an ATR System

Systematic option selling with ATR:

Weekly Put Selling

  1. Calculate 1.5× weekly ATR
  2. Find strike below this range
  3. Verify 0.20-0.30 delta
  4. Check support levels
  5. Size position by ATR

Rules for Consistency

  • Never sell inside 1 ATR
  • Adjust for earnings (2× ATR)
  • Reduce size if ATR expanding
  • Track ATR trends

ATR Screening

Finding opportunities:

High ATR Stocks

  • More premium available
  • Wider strikes needed
  • Higher risk/reward
  • Active management required

Low ATR Stocks

  • Less premium available
  • Strikes can be closer
  • Lower risk/reward
  • More passive approach

Match your style to ATR characteristics.

Key Takeaways

Average True Range (ATR):

  • Lower indicator measuring volatility
  • Shows actual price movement
  • Expressed in dollar terms
  • Guides strike selection
  • Essential for position sizing
  • 1-2 ATR rule for safety
  • Changes with market conditions

ATR is the option seller’s measuring stick, providing objective data for strike selection and position sizing. This lower indicator removes guesswork by showing exactly how far stocks typically move, allowing you to place strikes beyond normal ranges. Master ATR to transform from hoping your short strikes stay OTM to knowing the statistical probability. Remember: selling options inside the ATR range is gambling, while selling outside is investing.