Anyone who has followed my stream on StockTwits.Com knows that I’m a big fan of unusual options activity (UOA). A lot of my posts on StockTwits, Twitter and my trading room are regarding UOA. A lot of my trades are based around it in fact. However, I learned the hard way on a few occasions by not understanding the reasoning behind some of the activity and indeed, blindly following it. I hope this post saves at least one person from being tricked by the aspects of UOA used for market manipulation or reasons you aren’t even thinking of

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Unusual Options Activity

I should probably start with a quick definitely of unusual options activity: it’s when options are opened on a given day at a higher volume that they have not been traded at for a set amount of time.

I use several tools to find unusual options activity, my favorite being TDAmeritrade’s Think or Swim Platform, as well as trade-alert, and WallStJesus. Their services are excellent. I use them as shortcuts to find option contracts with volume that exceeds open interest during the trading day. If the volume of a trade is greater than the open interest, it implies that the position was opening.

Other factors include “sweepers” (buyers of options that buy everything available across multiple exchanges) and if the trade is placed on the bid-side or the ask-side. Hitting the bid-side (having the trade executed at the “bid”) often implies the selling of an option and filling a trade on the ask-side often implies buying.

So Why Doesn’t Everyone Just Trade Unusual Options Activity and Get Rich?

Because there’s trickery in all of this. Warren Buffett, despite his use of them (his smart use of them), has called financial derivatives like options to be weapons of mass destruction.I’ve seen the social media financial outlets explode with comments when thousands of contracts hit the tape vs. the open interest, with those contracts set to expire that same week.

Suddenly everyone gets super bullish regarding the stock. Why else would someone be spending so much money buying so many calls (or puts) with such short expiries? Surely they know something, right?

Probably Not.

Those orders are generally hedges. If you are short a stock (an actual stock short, not a Put) buying ITM (in the money) or ATM (at the money) calls at a price lower than you shorted at is a hedge. What it means for that trader, if the stock runs up then they’d be able to cover their short position for less than they otherwise would’ve been able to

For example, if you were to short (sell to open) $AAPL stock, you would essentially make a penny for each share you shorted of $AAPL. Let’s say you shorted $AAPL at $140 then it started to spike up, or the market conditions were such that $AAPL was likely to move up. If you bought $135 strike $AAPL Calls, you would still be able to “cover” your short position @ $135 rather than say the $150s where Apple is trading right now. Remember that options can be exercised, meaning if you own the $135 Calls, even if $AAPL went to a $1,000, you would still have the right to buy 100 shares @ $135 each for every contract/call you owned of Apple.

I see retail traders get tricked into believing such purchases are super bullish nearly every day, when in fact they’re somewhat of the opposite.

Other ways of ‘tricking’ retail investors with unusual options activity exist as well. In the first “Wall Street” Movie, there’s a scene where Gordon Gecko tells Buddy Fox to buy a ton of calls then bid up a stock…virtually guaranteeing that the calls will be worth more. This sort of things goes on every day, and traders are suckered in by it all the time, despite Oliver Stone tipping us off to it in 1987. Trust me, this sort of stuff is still very commonplace in the market.

Then there’s the call or put sweepers who buy enormous amounts of options RIGHT before analyst upgrades or downgrades on a stock. If you think this to be coincidence, I wish I had your innocence. The stock market is manipulated by the people with the money to be able to manipulate it. If it weren’t, stocks would be less volatile than bonds, and ‘options’ and ‘trading’ would likely not even exist.

There’s plenty of other tricks out there which I’ll get into as this blog develops. This post is merely intended to inform you that not all UOA is the sort of thing to be followed blindly. In fact, no trade should be followed blindly despite the credentials of the trader posting the trade. It’s something I tell my followers every day; you have no idea why I’m taking on a trade and unless you do…don’t take it on until you do. You’re always welcome to ask me why I am as well.

Cheers,
Rishesh
“androsForm”