What is Unusual Option Activity?
Unusual Options Activity, also known as UOA, occurs when there is a large number of options traded for a given stock at an unusual rate. While there are lots of regular options trading that happens everyday, unusual options activity is when abnormally large options trades are made, usually as a large bet or for hedging.
Unusual Options can provide insight on what "Smart Money" is doing with large volume orders, signaling new positions and potentially a big move in the underlying stock. Identifying a trend utilizing UOA data can give you an idea of how "Smart Money" in Wall Street are feeling toward a particular stock. UOA can be a great tool for idea generation so we can follow professional traders and identify stocks we otherwise wouldn't have notice.
Not all unusual options trades may be a directional bets—it could be someone hedging stocks or a complex multi-leg strategy. There are numerous Unusual Options Activity scanners in the market that only provide you simple put-call ratio, which can be misleading. Here at FlowSniper, we want to equip you with the proper tool and knowledge to better identify and analyze the true motive of professional traders and institution.
Expiration Date is a key factor to analyze UOA data as it demonstrates the potential investment time horizon of associated traders. Additional time until a contract expires allows more opportunity for it to reach its strike price and grow its time value. Institution that purchase option contracts with long expiration (>1 year) may have a strong stance on its future value, with little concern to short term price fluctuation. For people wanting to utilize UOA to make short term trade, we will want to focus on UOA with closer expiration date (< 3 months). Remember, the longer the time, the more variables that can affect outcome and harder to manage.
Trade Initiation is perhaps the most important factor to considered when analyzing UOA data because it tells you the true motive behind every UOA transaction, if a transaction is initiated by a buy order or by a sell order. To understand trade initiation, we must first understand that there are two side for every option trade, the buyer and the seller. Most of the time, traders are dealing with Market Maker, regardless of buying or selling. The duty of a market maker is to provide liquidity to the market, and they are heavily hedge against both side, meaning that they are not betting on stock price going up or down regardless of what option contract they purchased or sold.
In short, for a call, a sell initiated can mean both closing a position or selling to open for credit. Regardless, both are considered to be bearish for the underlying security.
Call: Initiated by a buy - Bullish, Initiated by a sell - Bearish
Put: Initiated by a buy - Bearish, Initiated by a buy - Bullish
For example, a stock with $100 million worth of call purchased today might sounds bullish, but it may mean the exact opposite if only 10% of them were initiated by a buy order. This tell us that in reality, 90% of that $100 million were traders selling their call position, with market maker are on the other side purchasing it. Remember, although market maker is purchasing these call contracts, they are only doing so to provide market liquidity and is heavily hedged against any stock price movement.
The strike price of an option contract can be an useful tool. When analyzing UOA data, we generally want to focus our attention to contracts that are in the money (ITM) as it will more likely to be a directional bet. An option contract will cost more if it's ITM since the contract has more intrinsic value, thus it's reasonable to assume that traders who invest a substantial amount of capital into a deep ITM contract have more confidence in the underlying stock movement.
Delta is the ratio that compares the change in the price of a stock, to the corresponding change in the price of its option. For example, if a stock option has a delta value of 0.55, this means that if the underlying stock increases in price by $1 per share, the option on it will rise by $0.55 per share, all else being equal. Delta will be higher if the contract is more ITM. Contracts purchased with low delta is more likely a product of delta-hedging or volatility related strategy employed by institution, which isn't indicative on future stock price. The concept of analyzing delta goes hand in hand with strike price. In short, UOA with an ITM strike price and high delta is more likely to be a directional bet on its underlying security instead of hedging.
Generally speaking, an at-the-money option has a delta at approximately 0.5 or -0.5.
As the name suggested, relative volume or RVol, is a ratio that calculates current volume to average volume of any particular stock. A high relative volume tells us that there is increased trading activity in a stock, and vice versa. A high relative volume may indicate that something unusual may be happening.