Finding Unusual Options Activity
Unusual options activity (or “UOA”) can be a “giveaway,” so to speak, that there could be a large move in the underlying stock in the near future. UOA is typically sparked by hedge funds and institutions, as they trade the options market regularly with very large trades to gain profits on the massive leverage that options can provide. It is very common for these institutions to position themselves in advance of a pending news announcements, such as a buyout or bankruptcy, that may not have gone public yet. These insiders are often referred to as “smart money.”
A strong strategy for retail traders is monitoring regular options order flow (not just UOA) to spot what “smart money” is doing and follow along in the most profitable way possible. Although UOA is tricky, using this strategy can see potential gains that are ridiculous.
If you are not familiar with listed options, they are labeled as either “calls” or “puts.” A call gives the buyer the option (or right) to buy the stock at the expiration date (usually 100 shares) at the purchased strike price, while puts give you the option to sell the stock. A call buyer takes on a bullish bias, while a put buyer takes on a bearish bias.
I strongly urge you to do some homework before ever considering selling either calls or puts. However, when you buy either, your downside is always limited to your capital invested. When you sell either, downside can be infinite (similar to short and long trades). This write-up will touch on call buying with unusual options activity.
What Makes This Activity “Unusual?”
At or Above Ask Price
Look to see if the trade took place at or above the ask price. Such a trade would indicate that the buyer was very aggressive, and willing to pay the premium price to execute the trade. Trades at or above the ask tend to be much more significant.
Size vs Daily Avg.
UOA is defined by the size of the trade, but just looking for the biggest trades won’t get you too far. The average sized trade for that particular name must be compared. As an example, 1,000 contracts traded in an $MSFT option would not be considered unusual, since Microsoft trades much more than that on a daily basis. Those same 1,000 contracts traded on a less liquid name would certainly be a more significant. Roughly 4 times the normal volume would typically qualify as unusual.
Volume vs Open Interest
Compare volume to open interest. Open interest (or OI) represents exiting positions that are outstanding, that are still needing to be closed. If volume exceeds OI, you know that someone is opening a new position, which has far more informative value than that of a closing one.
Implied Volatility Change
Implied volatility (or IV) displays the overall expectation of future volatility. Therefore, an increase in implied volatility is a more valid trade signal than a larger order that has a lesser impact on IV.
Tracking Unusual Options Activity
The process of breaking down what is considered to be valid unusual options activity can be daunting. It seems like a lot of analysis to perform on one trade, but options scanners can handle all of this for you in a very streamlined way, taking out a lot of the guess work. Several viable platforms are available like OptionAlert and Wiseguys. I prefer to use Optionsflux to find potential unusual options activity based opportunities. The UOA toolbar on their platform alerts to these sort of setups all day long.
Lets look at an example…
Looking at the UOA toolbar above, I can see that $LM is showing 26.05 times the average volume. Additionally, the toolbar tells me that 95% of that volume is in calls. If I double click on $LM, I can watch the order flow throughout the day, or see where that 26.05 times average volume is… or rather where it’s currently sitting.
After analyzing order flow and volume, I can see that 1542 contracts are currently sitting in 33 calls to expire on 10-21-16, and I can see where the majority of the 95% of calls went throughout the day via top volume. Time to pull up the chart…
Looking at the daily, I can see that price looks to be bouncing off of the 200 dma, as price broke and closed below it yesterday… only to break back above it today.
Digging a little further, I can see on the 60 minute chart that price created a coil (or symmetrical triangle) around the POC that broke down and has now put in a golden retracement to the 1.618 Fibonacci level. Based on the move that followed the 1.618 touch, I’d say we already missed the majority of this move. However, the UOA calls may have paid off for those that spotted it sooner.
Following up on this trade several days later, we can see that the action shown on the previous chart was where the high was put in. While the 33 target wasn’t hit directly, it made a high at 32.98… close enough for anyone that followed into the 33 calls.
While these setups are not a 100% guarantee (nothing is), they can lead you to find hidden gems in the market with the major potential of moving in smart money’s favor, very quickly in some cases. Note that timing on some of these can be crucial. If smart money is playing weeklys, you may miss much of the move if you come in late, much like the $LM scenario above.
Never take a trade simply as a result of smart money activity. Pull up the chart for yourself. Analyze what you see. Figure out “what would cause them to take such a large position here?” Trade it for yourself, with smart money as your reassurance. While I’m not a fan of UOA for my main trading plan, extremely profitable situations can arise from such scenarios. However, trading UOA can be tricky. Literally hundreds of thousands of options orders are reported every day. That leaves a lot of “noise out there.” Again, make sure you trade the name for yourself, not just because you saw a large order go through.
In most cases involving weekly contracts, the trade (for smart money) could last a matter of minutes up to several days. Contracts that are further out give you more time to adapt, wait for key entries, adjust charts, add/trim, etc. and carry less overall risk, but won’t see gains near as quickly as weekly OTM contracts. Read more about time related options trading in The Value of Time.