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If you read Twitter or follow any kind of stock-related media, chances are good you’ve heard the term “unusual options activity.”

While the basics are self-explanatory – the phrase is used to describe an option transaction that is abnormal in size and scope – there’re conflicting opinions on what such trades may mean and how to interpret the information.

Let me teach you my approach to unusual options trades, show which trades I pay attention to, and give away 2 stocks I’m following in the light of recent abnormal trades.

What is Unusual Activity

I don’t have a specific definition or a set of criteria and generally, just go by common sense: you know unusual activity when you see it.

If we’re looking at an average stock, on a normal day it trades say 500 Call option contracts across all “around-the-money” strikes, and then you see one print sweeping 7000 Calls far out of the money – that’s pretty “unusual”, right?

I know this isn’t the most scientific approach, but you see where I’m coming from?

Every stock and every contract is different, but if something very clearly stands out – you might wanna take notice.

The next question naturally is why pay attention to it?

Now, I’m no big conspiracy theorist + the market rules regarding insider trading are very strict – thus, whenever I see a highly unusual trade, I tend to avoid the common “somebody knows something” conclusion.

From my experience, the number of cases when a trader truly does exploit non-public info through an excessive options bet is extremely small – I would never enter a meaningfully sized trade solely based on that.

The truth of the matter is – most of the unusual activity can be easily explained away as:

  • Hedging: in an example above a 7000 contract sweep may look huge for me and you, but for a fund manager that’s holding 700,000 shares short it’s drop in the ocean.
  • Part of a complex options spread trade
  • A speculative directional bet by a big trader

However, there are 2 specific situations I watch out for…

Price Action Follows Unusual Bet’s Direction

In my view, an outsized options trade doesn’t mean much by itself… unless the price action confirms it!

I like to see how the market reacts to these trades – if a stock starts trending in the direction of the unusual bet, I always take note.

Whether there truly is fundamentally changing insider info that gets known to more market participants or simply a wave of buying/selling triggered by the unusual options trade itself – as long as there is a trend, I’ll gladly partake.

If there’s a notable change in a stock’s character post such trade – there could be a great opportunity.

Here’s one such name I’m watching:

KE Holdings – BEKE

There are a few things to like here. For one, the stock is in a clear downtrend on very significant volume and can’t catch a bid.

Then, over 49,914 contracts were traded on the $10 strike put option at the ask, expiring on September 17th, 2021 – a trade representing potentially nearly 5M shares!

That’s a huge bet on the downside!

I’ll be watching for continued weakness and if there’re more fails in the $19 area, I may position myself short.

Unusual Number of Calls Are Getting Sold in an Uptrend

Here’s perhaps the biggest one – I really pay attention when I see continuous sales of calls, especially if a stock is trending higher along the way.

See, call selling is one more way to bet on a stock’s downside.

As momentum names run higher, volatility increases, and premiums quickly get more expensive – that’s when downside traders may start betting on their quick shrinkage when the shares make a pullback.

The mechanics are similar to shorting a stock: traders sell calls, collect an expensive premium and then hope to re-buy the contracts lower, as shares deflate and option prices shrink.

If they sell too many calls too quickly and the stock fails to go down and give them an exit – we may get a situation that’s very similar in nature to a short squeeze: traders who sold Call contracts now have to deliver the shares to the buyer are forced to buy at any price.

To identify such opportunities, I look for recurring high-volume sales on the bid.

In the example above, you may not see one big block trade of 7000 contracts, but if there are multiple transactions of 500-1000 contracts on the bid every day, I’d sure pay attention.

Here’s one stock that’s actively trading higher with some notable call sales on the bid:

Support.com – SPRT

Just 2 days ago there was a 5,000 contract trade in SPRT on the $23 strike call option, filled at the bid – exactly the kind of trade I’ve just described.

The contracts expire on October 15th, 2021, and represent potentially 500,000 shares of additional demand. The open interest in call options has also steadily grown.

The stock has been squeezing higher over the past few weeks, as it sports a nearly 39% short interest.

Given the chart, we can easily see more upside, only fueled by all stuck Call sellers. I’ll be watching out for any protracted holds above $14 for a potential move into $20.

Author:
Jason Bond

4 Comments

  1. Thanks, Jason! I would really appreciate more examples of what kind of short interest to look for, and short floats. Thanks, KD

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