What is unusual options activity?
As the term implies, unusual options activity refers to a stock whose option contract (or multiple contracts) are showing unusual behavior. Specifically, many investors and traders use a simple definition of an options contract whose trading volume is five times higher compared to its average daily trading volume.
For example, suppose a call option on ABC stock trades on average 5,000 contracts a day. This means that some days it can trade 4,000 contracts and other days 6,000 contracts. So naturally investors would be interested to investigate why the volume soared to 25,000 contracts.
What does unusual options activity mean?
So what happens if one day you notice an unfamiliar option chain ranking in an exchange’s “most active” list? First, it is important to understand that by default, unusual options activity does not translate to a bullish indicator. In fact, unusual volume could merely be consistent with a large investor using the options market to hedge a trade, meaning their primary objective is risk management and not profit-taking.
Why can options experience unusual activity?
Stocks can experience unusual activity on the underlying option contracts for several reasons. Some of the more common factors include:
1) a single large institution is entering or exiting a position
2) there are rumors of a pending merger and acquisition
3) speculation of forthcoming news
Regardless of the reason behind the surge, investors should actively seek out and pay close attention to option chains experiencing unusual volume. Many investors equate options traders as being part of the “smart money” crowd given the higher level of complexity compared to stocks.
How to find unusual options activity?
Investors can easily find unusual options activity by using one of the many scanners that are available on the market. Some brokers offer scanners to their customers for free while many investors and traders prefer to pay a monthly or yearly subscription fee to access an advanced scanner with added analytical tools.
Buyer beware
Unusual activity and what it means for Call options
Logic dictates that call options are a bet on the price of the underlying stock moving higher. But such is not always the case and this could lead to some investor confusion when an investor discovers unusual options activity.
But each option trade consists of two separate sides: the buyer and the seller. A large seller of call options could be motivated by generating additional yield after they acquired the underlying shares at a very low price. This means the seller may be looking to write large amounts of options and fulfill their obligation to liquidate the shares.
This is far from a bullish sign and could lead investors into the trap that unusual options activity by default is a bullish signal.
Unusual activity and what it means for put options
The same logic holds true for put options. Unusually large put activity may initially point to a bearish sentiment. But a large options player could be selling large quantities of put options as part of a bullish strategy.
While this may seem confusing to novice investors, this emphasizes the need to constantly dig deep and do additional due diligence. The objective is to evaluate if an unusual trade is part of a hedge or a speculative exposure strategy.
Unusual options activity are a good starting point
It is worth repeating that unusual options activity by default is not a bullish nor bearish sign. Also important to keep in mind, it is likely unclear the reason why one or more institutions are taking a sudden interest in an options contract.
That said, unusual options activity remains a preferred starting point for many traders and for short-term investors looking to take advantage of a unique scenario. If an investor is able to identify a catalyst that would warrant a large move, they are one step closer to implementing and executing a trading strategy based on their perceived outlook.
Key takeaways
- As the term implies, unusual options activity refers to a stock whose option contract (or multiple contracts) are showing unusual behavior.
- Unusual options activity by default is not a bullish nor bearish sign. In fact, unusual volume could merely be consistent with a large investor using options market to hedge a trade. This means that their primary objective is not necessarily to earn a profit from the trade.
- Stocks can experience unusual
activity on the underlying option contracts for several reasons.
Some of the more common factors include:
- a single large institution is entering or exiting a position
- there are rumors of a pending merger and acquisition
- speculation of forthcoming news
- Investors can easily find unusual options activity by using one of the many scanners that are available on the market.
- Logic dictates that call options are a bet on the price of the underlying stock moving higher. But such is not always the case and this could lead to some investor confusion when an investor discovers unusual options activity.
- This emphasizes the need to evaluate if an unusual trade is part of a hedge or a speculative exposure strategy.
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