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How To Profit From Unusual Options Activity

Jeff BishopJeff Bishop ·

Unusual Options Activity

What if you could legally steal some of the best ideas from the largest players on Wall Street?  Well, sometimes you can, that is, if you follow unusual options activity. Now, this isn’t a different asset class, it’s just a term used to describe stock options that are experiencing greater than average volume.

For example, there were  6,738 calls of Delphi Technologies (DLPH) that traded on January 14.

What makes this order stand out?

  1. Well, on average, Delphi only trades about 600 option contracts per day.
  2. That said, it traded about 11 times its daily average.
  3. An unusual options activity order is one that stands out and is relatively large.

For example, on that same day, over 2.2M options in the SPDR S&P 500 (SPY) contracts traded. However, their daily average contracts are 3.8M. In other words, it’s not the size that matters, it’s the relative size. Because of that, 6K contracts traded in DLPH is considered unusual, whereas 2.2M contracts traded in SPY is not.

How does one go about finding this information?

Well, according to the rules of the game, every option trade that is placed (electronically, on or off the trading floor) must be reported and made publicly available. That said, there are hundreds of large option trades that are placed daily. Now, most trading platforms will provide options information like volume, open interest, the price range of the option strike. For example, here is what an options chart on thinkorswim looks like:

tos unusual options activity dlph

source: thinkorswim

As you can see from the giant cyan (blue-green) volume bar on 1/14, there was an unusual amount of options traded on the March 17.5 calls in Delphi.

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Not All Unusual Options Activity Is The Same

Here’s what we know about the Delphi trade:

  • 6,500 DLPH March 17.5 calls traded for $1.00
  • The trader spent $650,000 in option premium
  • The stock was trading around $16 at the time of the order
  • Delphi has earnings on February 20.

During the time of the trade, the March 17.5 calls traded for a $1.00. However, the spread on the trade was in $0.85 by $1.05. In other words, the trader was relatively aggressive because they bought near the asking price. Not only that but those contracts had an open interest of about 300 contracts. That said, the 6,500 calls that traded is an opening position. You see, if this was an exiting position, there would be at least 6,500 contracts of open interest.

Moreover, option trades that have more volume than open interest look more compelling for possible trade candidates.

We know the trader spent over $650K on this one single trade. That said, we are not dealing with a mom and pop trader here. Furthermore, Delphi has earnings on February 20, and these calls that were bought cover the earnings date.

Does this mean that Delphi is going to rise ahead of its earnings release?

Not necessarily. You see, when you buy a call option your risk is limited to the premium you spend. That said,  buying calls is usually not as risky as holding a stock position before its earnings event. For example, if shares of the stock plummet, your stop might not work. In other words, you can end up losing more than you wanted because of an opening gap lower.

In other words, if this trade is a stock substitution, where the trader is replacing the stock with calls then this trade is not as bullish as it first appears. It could be very well that this trader is playing the earnings event.

They’re Sometimes Predictive In Nature

On January 11, a couple minutes before the close on Friday, a trader came in bought 4,674 PCG 12 puts for $1.00 per contract. At the time of the trade, the stock was trading at $17.50. Now, this was a fairly massive bet, especially when you consider how far out-of-the-money these puts were. However, if you were following PG&E story closely, this bet was not as crazy as it appears.

You see, there were rumors that the utility company would not be able to support itself after facing liability charges of $30B or more for the deadly wildfires caused in California.

pcg unusual options activity

Source: Bloomberg

That said, the following trading day, PG&E, California’s largest utility company was going to be filing for bankruptcy. That said, those Feb 12 puts … rose by more than 366% in one single day. If they took profits, the trader made approximately $1.5M in profits.

PG&E unusual options activity

Source: thinkorswim

Not bad for a day’s work.

f u cn rd ths msg, u 2 cn dbl yr prfts w optns

How To Scan and Filter for Unusual Options Activity

Why would anyone put a large sum of money on an option trade, one so large to execute that the trade must be placed with a floor broker?

Maybe they are informed. After all, they have ton’s of money and Wall Street connections.

So how can we figure out the juicy trades from the noise?

Well, like any indicator, scanning for unusual options activity doesn’t work 100% of the time. Furthermore, its best paired when you know things about the company or the story. Of course, at the end of the day it’s all speculation, but here is what I look at:

  • Volume should be greater than open interest- opening position.
  • Orders should be on the ask side, sometimes you’ll see some that are above the asking price
  • Avoid orders that have the earnings month, as they are most likely a play on earnings
  • Relative size is more important than actual size; anything above 5X is worth looking into
  • Pay attention to relative stock volume too; stocks that trade less volume and have options that are are worth examining
  • Call options work great in any market environment. However, put options work best during bearish markets.
  • You want to see large spikes in implied volatility following the options order
  • Become your own detective and try to figure out why someone might placing an unusual options activity. Yes, that means reading the news, even though a lot of what’s out there is junk.
  • Options that are experiencing unusual activity on more than one line are more interesting. For example, PCG had puts trade on different strikes and expiration periods.
  • Look for repeat offenders. Sometimes these  trades can go on for a long period of time. For example, a trader can be successful, then close out that position and roll over to the next contract. It’s worth tracking because you want to follow other successful traders.

Using unusual options activity data can be helpful in your decision-making process. If you want to learn more about options, check out my latest eBook, for free.

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