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unusual options activity

Why I Only Follow Those Who Have Skin In The Game

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Why I Only Follow Those Who Have Skin In The GameNow, when it comes to financial television, my favorite way to watch it is on mute. I could care less about their opinion on the stock market. After all, they don’t call them talking heads for nothing. I mean seriously, how active can these people be in the market?

Don’t they have positions to monitor, ideas to generate, research to do, trades to enter or exit? Silly me…if they were actually doing that, they wouldn’t have time to tell us where they think the market is going next.

To be honest, the reason why I stopped providing commentary to the financial media is because it proved to be a distraction that took away time from my trading and clients.

Why would I take advice or follow someone who has no skin in the game…someone who has nothing to lose if they are wrong? It makes no sense.

Just follow the money trail.

Even before I founded OptionSIZZLE, I’ve always focused my attention on the real-money players, the institutions and hedge funds who make (or lose) fortunes from executing their trading ideas. For me, nothing gives an investor more information on the future direction of a stock than watching unusual options activity.

After all, they have hundreds of thousands of dollars (sometimes multi-millions) riding on these make or break decisions.

Now, if you don’t know, unusual options activity is simply above average volume on a particular stock option. What makes it so unique, unlike watching stock order-flow, is that we can identify if these are opening positions (new trades).

How so? Simple, every option contract traded on a stock has volume and open interest.

Now, of course, volume refers to all the options traded on a specific stock option (strike price) on that day, which includes options that are bought or sold. Well, naturally, open interest refers to all the contracts that are outstanding (open positions that have yet to be closed out) for a specific option contract (strike price).

For example, if someone buys 4000 Micron 24 calls (expiring 4/24/14), with 1000 contracts of open interest…we know for a fact that thisis an opening position (new trade). However, we don’t know if the trade was placed as a hedge against a short stock position or if it’s speculation that the stock trades higher.

Of course, trying to figure out the WHY is the most important element…even though we’ll never know for certain. That’s why I’m always looking for ways to connect the dots. Now, it doesn’t matter if you’re an investor or trader…knowing how the smart money is positioned is mega-valuable information.

Let’s look at a recent example to see how this all works.

On Wednesday, March 12, there was a large put buyer in Con Edison (ED) at around 12:15 Eastern Time, when the stock was trading at $54.59. They came in and bought 9,294 April 52.5 puts for .35 per contract.

At the time of the order, the bid price was .25 and the ask price was .35. The open interest was 52 contacts.

Of course, we know that this was an opening position because volume was greater than open interest. In addition, we know that this was an aggressive order because the trader was willing to lift the offer (buy the ask price) vs. trying to buy the options at the mid-price (.30).

The order gave the trader the right (but not obligation) to be short 929,400 shares of stock. Now, what made this order interesting… is that ED on average trades 983 option contracts a day.

On Wednesday, it traded 22,670 contracts… 98% of those contracts were puts! Again, that’s 23 times usual options volume.By the way, this is unusual options activity at its finest. However, we don’t know why they put this order on.

We’re assuming whoever put the trade on is an informed trader…after all; they’re willing to bet over $325k on their idea…putting their money where their mouth is.

Again, is this speculation or a hedge? I have series of questions that I rundown whenever an unusual options trade interests me. Allow me to share some with you.

First, is this speculation on upcoming earnings? Probably not, their earnings are on 5/01/14…we can scratch that off the list.
Is this a hedge against a long stock position?

Possibly…however, I like to look at a chart to see if the stock has been in an up or down trend. If the stock is trending higher, they might want to buy puts to protect their profits and hedge.

Why I Only Follow Those Who Have Skin In The Game

Well, for one thing, the chart looks pretty weak…it’s hard to imagine someone hedging a long stock position with such a bearish looking chart. Speculation that the stock drops further vs. a hedge makes for a more compelling argument.

Moving on.

Are they presenting at a conference or have been recently downgraded? No and No.

You see, it’s important to have a corporate calendar nearby in order figure this stuff out. In addition, you should search for any related news that could possibly give us hints on why this large option trade went through.

If you don’t subscribe to any news services, you can always use Twitter… a lot of times they’ll break news quicker than financial television will.

In this case, Twitter was very useful.

Why I Only Follow Those Who Have Skin In The Game

It turned out earlier in the day there was a horrific explosion in East Harlem, New York. Sadly, it left several people dead and injured. First, let me say, my thoughts and prayers go out to anyone affected by this tragic accident.

I’m still shaken up from hearing about Malaysia Flight 370 over the weekend…hearing about this accident in New York, only reminds me how precious life is.

Now, was Con Edison at fault?

Is there a potential lawsuit in the works?

Is this why they bought these put options?

I don’t know…but it could be a potential catalyst to drive the stock price lower.

Well, on Thursday, Con Edison was downgraded at Barclays, the stock price declined 1.7% and those put options traded as high as .70 per contract…doubling from where the large trader initially got in.

We were able to identify this as an aggressive unusual options order…we’ll never know why the trade was put on, but felt there was a catalyst behind the order… along with a weak looking chart.

At the end of the day, finding unusual option trades is easy…trying to figure out the WHY is always going to be the challenge. Currently, I’ve written two reports, outlining my process in full detail, along with providing tons of examples for what constitutes as worthwhile opportunities (and which ones don’t).

As you can see, it pays to follow those who have skin in the game. Think about it, these large option trades are placed by some of the sharpest minds on the street, they probably have an army of research analysts and access to information we simply can’t afford to get our hands on.

Now, I’m not advocating that you should start trading off unusual options activity.

What I’m saying is that you should strongly consider incorporating it in your research and decision making process. As my go-to indicator, it’s proven itself countless times.

To learn more about how you can use this can’t miss indicator…

Click on the button below, don’t worry, the report is 100% free…

…Inside I’ll teach you how to:

Hand-pick potential big movers

Weed out the noise

Track activity using my proven method

Nail the approach down by learning from case studies

And much, much more…

Options Trading Case Study – Unusual Option Activity In AXL

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I just recently hosted a webinar, where I went over what is unusual option activity and why I feel every options trader should follow it. The quick answer to the why, is that to me this is as close to a “real time” trading indicator than anything else out there. Money being put at risk is different than someone coming on TV saying they “like” the stock. I go back to the school of thought of follow the money and I will show you why following the money paid of in American Axle Manufacturing Holdings (AXL).

On November 11, 2010 I noted unusual buyers coming into the November $11 calls, where 5472 contracts traded that day with an open interest of 1,394 contracts. Pretty obvious buyers where coming in with trades hitting the offer (indication of buyers) at 10 cents and implied volatility moving higher by 16%. Here are a few reasons why this is unusual.

1) Market was very bearish that day, with the S&P 500 closing down 1.56%

2) Shares of American Axle closed down 4.15% closing at $10.39

3) Call buyers coming into November calls with three days to expire

4) The options trading activity was 3x the normal amount of options traded during the last 22 days

If this does not make sense, I will break it down. The traders paid $10 for each option contract to control 100 shares of (AXL) stock at $11 before November expiration. The total amount of money put up yesterday was $54,000 for this trade. This is not to much money, but here’s the thing, they only had three days to be right so they were risking $54,000 for an all or nothing trade. With the market and shares that weak, what could they be possibly betting for, a bounce?

Well shares did bounce the next day, a good 7.31% with shares currently trading at $11.15 as I write this. The reason for the bounce? JPMorgan Chase (JPM) came out before the market open with an Upgrade on shares to an Overweight from Neutral, while raising their target price to $14.

Pretty interesting, that less than 24 hours before there were buyers of calls to own shares above $11. Currently the price of those November $11 calls are trading at $.30x$.35, a 200% gain on the trade. So do you think this was lucky or someone knew ahead of the rest of us? Leave a comment below.

Here is what I provided to my members in my live chat room: (click to enlarge)

 

If you are interested in learning how you can track this activity on your own, then you will want to check out our course on how to track unusual option activity and trade it. Click here to learn more about it.