What Does Unusual Options Activity Mean and Does It Work?

Do you know how to profit from unusual options activity? Open interest shows the amount of open options contracts. When you see an usually large amount of open interest with particular strike prices this might mean a potential big move is about to happen in the stock because this is where big money traders might be sitting.

You might think the stock market is a loud place, and I’d have to agree. With all the movement, activity and chatter, its easy to get lost in the noise.

But what if I told you that underneath all this noise, lay the clues for your success. What if these clues were whispers just waiting for you to hear them?

The answers are there if you just take the time to listen. You can learn how to profit from unusual option activity if you take the time to listen to the whispers.

What Triggers Unusual Options Activity?

  • Options are the drug of choice for hedge funds and large institutions, due to the massive leverage and profits options provide. For these reasons, hedge funds and institutions frequently spark unusual options activity (UOA). It’s very common for them to position themselves in advance of pending news announcements (i.e. an upcoming buyout or bankruptcy) that may not have gone public yet. Not surprisingly, these people on the inside are often referred to as “smart money” because they are in the know.

Somebody Knows Something

Options are traded regularly in options markets – no surprise there. But, when activity on an option starts to look unusually high, it is a sign.

Unusual options activity (or “UOA”) can be a “giveaway,” so to speak, that there could be a significant move in the underlying stock shortly.

In fact, make sure to take our options trading course. That way, you learn the basics of options and can take advantage of UOA.

Why Should You Follow Unusual Options Activity?

Let me ask you this: What if I told you that you could get inside the trading minds legally copy the trading of the largest players on Wall Street?

Well, you can, if you follow unusual options activity. Now, don’t be confused if you’ve haven’t heard this term before. We use this term to describe stock options that are experiencing greater than average volume.

A Real-Life Example of Unusual Options Activity

  1. Have you heard of Delphi Technologies? Well, on January 14, 2019, there were 6,738 calls of Delphi Technologies (DLPH) traded.
  2. You’re probably wondering what makes this order stand out?
  3. For two reasons:
  4. On an average day, Delphi only trades about 600 options contracts.
  5. On this particular day, January 14, it traded about 11 times its daily average!

In our books, an unusual options activity order is one that stands out and is relatively large. DLPH definitely looks like unusual options activity considering it was trading 11 times it’s daily average.

Let’s Put This in Perspective

To put this in perspective, let’s look at an example of SPY options contracts. On that same day, people traded over 2.2M SPDR S&P 500 (SPY) options contracts.

Seems like a lot, right? It’s not because considering the daily average of SPY contracts traded is 3.8M.

The takeaway is: It’s not the size that matters, it’s the relative size. In other words, 6,000 contracts traded in DLPH is unusual; 2.2 million contracts traded in the SPY is not.

How to Profit From Unusual Option Activity

As you can see from the giant bluish green volume bar in the chart, there was a usual amount of options traded on the March 17 calls.

In fact, this was significantly higher than the pink theoretical line on the graph would predict. Side note, make sure to set your trading rules before placing a trade.

Here’s a Summary of What We Know About the DLPH Options Trade

  • 6,500 DLPH March 17.5 calls traded for $1.00
  • Someone spent $650,000 in premium’s for the options contracts
  • At the time of the order, the stock was trading around $16
  • Open interest was 300
  • DLPH earnings were after the time of the unusual options activity.

When the trade happened, the March 17.5 calls traded for $1.00. Here’s where things get interesting, the spread on the trade was $0.85 by $1.05.

Which means the trader bought near the asking price. This is important because it means the trader was aggressive.

What’s more, those contracts had an open interest of about 300 contracts. For those of you unfamiliar with open interest, it’s just the total number of option contracts that are currently out there.

These contracts have been traded but just not liquidated yet by an offsetting trade or an exercise or assignment.

In this example, the 6,500 calls traded was an opening position. At this point, we know the trader spent over $650K on this one single trade and the calls were bought to cover the earnings date.

This is not some mom and pop trading operation here; something clearly is up. But, it’s essential to keep in mind that, frequently, unusual options activity is due to a large hedge taking place, rather than someone expressing a directional view.

The Writing Was on the Options Wall

Let’s look at another example. Just before close on Friday, January 11, 2019, a trader bought 4,674 Pacific Gas & Electric (PCG) 12 puts for $1.00 per contract.

At the time of the trade execution, the stock was trading at $17.50. Now, one would think this was a reckless bet, especially considering how far out-of-the-money these puts were.

How to Profit From Unusual Option Activity

But, if you were following the news, this bet was not as crazy as it appears….

For those of you familiar, this was the time of the wildfire that caused 86 deaths and destroyed around 14,000 homes, along with more than 500 businesses and 4,300 other buildings. Moreover, it’s believed the fire began when a PG&E power line came in contact with nearby trees.

Rumor’s were rampant that Pacific Gas & Electric wouldn’t survive the liability charges of $30B from the deadly wildfires in California. In this case, the rumor’s were true and in a public filing, they cited $7 billion in claims from the fire.

Not surprisingly, PG&E, California’s largest utility company, was going to be filing for bankruptcy.

Predictably, shares of PG&E (PCG) plunged 48% when the market opened that Monday. When you do the math, those puts bought on Friday rose by more than 366%. If they took profits, they made approximately $1.5M in profits.

Not too shabby for a day’s work if you ask me.

How You Can Scan and Filter for Unusual Options Activity

  • According to the rules of the game, every single option trade placed (electronically, on or off the trading floor) needs to not only be reported but made publicly available. Read that again and let it sink in; every single option trade place must be reported and made publicly available.

I think the question you must always ask yourself is: Why would anyone put such a large sum of money on the table in an option trade? One so big, in fact, that it needed to be placed with a floor broker.

Maybe somebody knows something; maybe they are connected. Which leave us to wonder, how can we find the signal in the noise? We can use an unusual options activity scanner. One of our favorite, and best value scanners for this is the quant data options scanner. Check it out.

My Criteria for the Unusual Options Activity Scanner

I’d be remiss not to mention that with any indicator or scanner, it’s not 100% accurate, 100% of the time. You need to not only apply a few filters; you need to apply some brainpower.

Continuously ask yourself why, why would there be an unusual option activity? Don’t just read the news, read in between the lines.

To filter out the noise and hear the whispers, I like to ensure:

  • Volume higher than open interest. If the volume exceeds the open interest, you know that someone is opening a new position. Knowing this has far more informative value than that of a closing one.
  • Don’t go near orders on an earnings month. Most often than not, they are a play on earnings.
  • Ignore actual size; relative size is more important. The first thing to remember is that looking for the biggest trades won’t get you too far. You need to compare the average trade size for that stock to the current trade size. As an example, take 1,000 contracts traded in a $MSFT option. It might seem like a lot, but it’s not considered unusual since Microsoft trades much more than that daily. Alternatively, those same 1,000 contracts traded on a less liquid name would undoubtedly be more significant.
  • Any relative size over 5x is something to pay attention to
  • Large spikes in implied volatility. Implied volatility (or IV) is the expectation of future volatility. Therefore, an increase in implied volatility is a more valid trade signal than a larger order with a lesser impact on IV.

Final Thoughts

You want to know what the smart money is doing, and you will know if you listen to the whispers. While the criteria listed above are not a 100% guarantee, they can help you cut the noise so you can find the hidden gems in the market. One thing to remember is all the day and swing traders are catching on that unusual options are a hot thing to trade. Regardless of the options flow, make sure you understand the candle stick chart inside and out, because just because its a lot of money being swept into a stock, doesn’t mean the person on the other end knows what they are doing.

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