What is unusual options activity trading, and how does it work?
Do you find it challenging to make profitable trading? Start analyzing unusual options activity. It alerts the trader if something noticeable is happening in stocks, stock price, or in the market as a whole.
Nowadays, the trading floor trend has vanished; the way to identify big money trading is left with the option to monitor through volume and stock screeners. For example, if an option that generally trades some contracts per day instantly trades 5000 contracts in a day, someone suggests that a big move is happening.
Unusual options activity might help you spot option contracts dealing at a higher volume than the contract's regular everyday options volume. This high-volume trading is sometimes dangerous and can get the bets wrong. However, sometimes UOA suggests that something big is going on in the underlying stock that can hugely benefit the traders.
What is unusual activity trading?
A contract that honors the buyer's right to buy and sell an underlying asset at a specific amount before or on the expiration date is known as an option. Unusual options trading activity is defined as the appearance of notable irregular trends in the order flow of the options chain.
The activity in the options chain market is crucial because many investors, insiders, and investment bankers are options. That is why looking at this data can provide you with more details on whether to buy a stock or not.
For instance, many insiders generally know if the company is in good shape or not. They contain the information that outsiders lack. If the shareholder is suddenly purchasing or selling a large number of stocks implies the company's condition and predicts the future of the stock prices.
This unusual options scanner below is an excellent example of what makes an unusual options order. Most of the orders below are over $25,000 for a particular option on an underlying security. Most retail investors don't have the capital to place these orders, so traders will follow these carefully to predict colossal movement.
Why trade Unusual Options Activity?
A large amount of daily volume in the stock market is done by hedge funds, successful private investors, and experienced options traders. These groups are well-informed and utilize a variety of different strategies. Therefore, this group is collectively known as "smart money or big money."
Hence, monitoring their daily activity provides essential insights into what big money is doing with the sector, stocks, or entire financial markets. So, you can take advantage and save yourself from facing a downfall.
When unusual options scanners show multiple orders for puts or calls with the same contract date or strike price, this could mean a move coming for the stock. Orders like this typically don't happen randomly and allow traders to see the stock movements sometimes before they happen. For example, below, we can see IWM has multiple orders for this current month's expiration date; we consider this unusual options activity.
Characteristics of unusual options activity
Every stock and options volume in the market shows activity daily. However, several specific characteristics have been assigned to UOA.
The volume options contract shows higher fluctuations than average. For example, it can be higher 5 to 10 times than average.
The majority of the daily volume of an options contract is from one substantial trade that indicates a more significant concentration.
Unusual options trading activity has far out of money options. So when UOA shows up for weekly OTM options, it is a strong indication that anyone knows anything valuable. That is why they expect a significant movement in the stock's underlying price over a short period.
How to trade UOA?
Having a thorough knowledge of UOA trading is as essential as unusual activity. We summarized the UOA trading in four steps for easy money trades. Let's walk through them.
Setup the trades
Once you have identified unusual trading activity, you need to set up your trade at trading platforms and boost up the possibility of making a profitable trade.
Look at the news for possible catalysts:
Take an instant look at all the news-related stock price that is the center of attention to figure out if there is an event coming up that might act as a catalyst and expose the reason for UOA in the stock at this time. It is not a big deal if you fail to find any news because whoever is trading might know something not public yet.
Check the past UOA flow:
By checking the past flow, you can understand if there has been previous activity and its results. In addition, it will offer you an idea about what to expect from these options contracts, bid price, and stock price.
Have a look at technical pictures:
Pull up a chart and look for technical indicators. It is usually a good sign if the graph is bullish with the bullish flow. Likewise, if the technology is bearish with the bearish unusual options activity flow, it is also a positive indication.
The information of stock price and prior trends help the trader make valuable and profitable trading decisions.
By placing momentum indicators on a stock chart, it is easy to see the direction of the stock. For example, looking at the graph below, we can see the stock is trending down, and this can also be confirmed by the Market Mover indicator and some EMA clouds, which are also bearish.
In the example above with IWM, there were many put orders that day telling us big money was predicting a possible bearish move in the stock. Looking at the stock chart, we can see bearish confirmation validates this large options activity.
Executing the trades
Now is the right time to execute the trade after current and past news and the stock flow.
Trade underlying stock or the same option contracts:
Going for the underlying trade is a wise option as it has many advantages. For example, you will not have to be tense about time decay. Moreover, it is also a great alternative if the option prices seem illiquid. Since there is already a lot of activity for the current option contract, it can be assumed there will be the same amount of activity in the future as the traders attempt to close the contracts.
Same strike price and expiration date:
Some traders will look to buy at the same strike price and expiration date that are active, but some also buy a further expiration.
Use accurate position size:
Position sizing is crucial. The size of your position is something you have control over when trading. It is suggested to never allocate more than 1% to 5% capital to any single trade.
Adjust for fills:
Often, a trader does not get the exact fill mentioned on the unusual options activity. Therefore, it is alright to chase it up to .50 or a bit higher or lower. However, it ultimately depends on the way options contracts are priced.
Managing the trades
After you have found your trade and have set them up and filled, you will have to manage your stock position to ensure that you get the most out of them. For managing the trade, this is what you need to do.
Traders generally have no idea what a prominent trader's time frame and intention are. Therefore, unusual options activity requires space and time, which means stops have to be wider than usual.
Utilization of the ATR:
If avoidable, stops should not be set on the options contracts. Instead, it should be placed on the underlying stock utilizing 1.5 to 2.0 x ATR. Traders should alert the underlying and sell the contract when it goes off.
Open interest tracking:
After entering the trade, he should monitor the open interest alterations to notice if the original position increases, reduces, or is closed. However, occasionally smart money moves on and closes out, and retail buying carries the trade a few points more before it downgrades because of lack of funds and genuine support.
Exiting the trades
Here are some different trading strategies to exit your trade
Utilize a pre-set target:
Once the options trader gets in the trade, he can set a pre-set target to exit. It can be several points on the underlying stock, a certain percentage, some key resistance or support level, or just an ATR multiple. Using ATR is a simple step in which a trader adds the underlying stock price.
Utilization of trailing stop:
After getting in the trade, the trader can set a trailing stop to keep saving or locking in gains and following the trend. It is more like a trend monitoring approach that facilitates option traders getting maximum profit from the trade.
If the trade is based on some events or news that was not apparent previously, the trader can close out the majority of the position after the information is known, and he can leave a runner on if there is some follow-through.
Open interest changes:
If the open interest ratio starts to dwindle, traders can begin to wind down the position. However, it is just a common-sense approach as a sudden increase and drop in open interest tells you that big money is making huge profits.
How to identify or track unusual options activity
The first requirement of identifying unusual options activity is the total volume should be doubles or multiplies of the average daily volume. Typically, it increases five times the average volume. When an option experiencing high relative volume is worth noticing, you need to pay extra attention to the options that make significant moves. It indicates that the institution making a bet may have some insider knowledge. However, a large individual order should be about the size of one day of average volume.
Successfully identifying unusual options trading is the key to success in the stock market.
Scanning of unusual activity
Scanning the unusual options activity holds great importance when it comes to trading. It provides insight into the past and future of the stock or what the stock price can be.
Scanning can be done by analyzing oneself, or traders are also facilitated with the scanners. However, both methods cannot provide 100% accurate results, but using an options flow scanner and doing DIY analysis will ensure a better chance of success in the trade.
One way traders will scan the unusual options activity is by sorting the premium for the trade. As you can see in the example below, these orders over 1 million dollars can be significant. Now, the key is to pair these large orders with your due diligence to find the golden opportunities.
Criteria for unusual options activity scanner
While analyzing the stocks oneself, here are a few criteria that you need to keep in mind.
Volume higher than open interest. If the options trades volume exceeds the open interest, the trader will understand that anyone is opening a new position. Having this information will be more valuable and beneficial than the closing one.
Relative size is more important than actual size. Remember that the most significant trade will not get the trader too far. Therefore, it is essential to compare the average trade size for the stock to the current trade size.
Average relative size. Any relative size five times larger than the original size is worth considering.
Spike in implied volatility. Implied volatility is a term used to define the expectation of future volatility. Therefore, a sudden increase in implied volatility is a valid trade signal than a larger order with a lesser impact.
These criteria will help in analyzing the options market manually. Moreover, it will also detect if the scanner is making distortion.
Scanner for an unusual options activity
Using an options scanner is the foremost step to identifying institutional trading and checking on institutional investors, but every trade does not mean the same. Therefore, it is essential to evaluate what sort of trade can be done and check activities accurately.
Here is one well-known options activity scanner that also provides large order flow analysis.
BreadAlerts is one of our favorite option data platforms as they provide a wealth of knowledge for option sellers and buyers.
Option sellers can use this platform to maximize option decay as BreadAlerts filters for the highest paying credit spreads and highest premium options to sell. This can be cash-secured puts or covered calls. This platform aims to find options over 3-4% per week and credit spreads with a 30% possible return on capital.
Option buyers can utilize the large orders to follow the big money moves to predict these moves before they happen. BreadAlerts use this data to provide Bullish and Bearish momentum readings and single stock analysis. This can help traders understand the information that can be moving quite quickly in front of their eyes.
Things you need to know about unusual option activity
Put and call options
It is crucial to understand the roots of the put and call options concept to understand the unusual options activity. The two are the main primary order types in the options market. Call options facilitate you with the opportunity to purchase stock at the predetermined level in a particular period. Conversely, the put option allows you to short a stock at a specific point. However, it is the exact opposite to the call options, but both put and call options hold significant importance in the trading industry.
Importance of large order flow
In the stock market, it is a famous saying that big money leaves footprints. Since large institutions move stocks daily, not an obligation, but it is crucial to monitor these footprints. If we have many large call orders, we will be assured that big money could be bullish. On the other hand, if there are significant amounts of put orders, they could be bearish. These orders do not ensure that the assets or stocks will move in that time and direction. However, their large order flows are just supporting evidence to support ideas we already hold about the particular stock. Or these orders might also facilitate discovering new trade ideas that give high bid prices.
Significance of low open interest and options trading volume?
Low options volume trading indicates that the options market for a particular asset is not active and can be a neutral signal. Moreover, low activity levels can suggest that the traders are unsure about strike price or option price movements and possess second thoughts about purchasing or selling options at their required or expected share price point.
Furthermore, it results in a lack of liquidity, making it hard to enter an order large. It will also make the trader pay the contract premium. Therefore, the trader should be cautious of these movements. Similarly, the same issue troubles at the time of selling underlying position. So while entering and leaving the same option with low option volume and low interest, the trader will lose share price twice.
Perks of high option open interest and volume
It is an essential aspect of the trading market because it indicates its liquidity level. More traders are interested in buying and selling options contracts when these aspects are high. This results in increased implied volatility and brings more opportunities for maximum profit. Increased volume to open interest provides the trader space and time to make the next move without negative influence. It makes a massive difference in strike prices for long-term trading.
Unusual options activity is the primary source to monitor what big money is doing. Smart money sometimes acts as a market maker or breaker of the stock because they include internal sources and know the core reason or unusual activity.
However, big money may lead you to profitable stock, and you must know how to trade unusual options activity. For this reason, we have listed the above criteria for scanning, some best scanners, and the method that will help you make a profitable trade and earn around strike price.
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