It is also important to watch the resultant volatility movements when option orders are coming through as generally aggressive buying of contracts will send Implied Volatility higher, specifically in the month where the action is hitting. On the other hand when a lot of size is selling on the bid Implied Volatility tends to take a dive lower, and this is rather self-explanatory. One rebuttal I often receive is that there is always someone on the other side of a trade.
Well, yes, but that completely misses the point, and this is about what and how much a trader is willing to pay to get into a large position, which inherently is a measure of conviction.
Furthermore, the other side of the trade is often a market-maker who will be on the other side of the options trade, but hedge off Delta-risk in the underlying stock, and therefore is not taking on directional exposure, but the Institution is in fact making a directional call. There are opportunities like this every single day.
Executive Summary
Also, Institutions are also wrong sometimes, so not every trade is going to work-out, it is a market after-all, and there are no guarantees with so many unforeseen factors in play. Generally speaking the larger the trade, the better probability of it becoming a winner because as noted before it shows the amount of conviction and I often refer to those as "High-Impact Trades". Also, a trade that involves more risk, such as a bullish risk reversal, tends to be one that is very confident and are often the best to follow.
Another secret that over the past two years has an amazing success rate and large profitable trades are to watch for large put sales in Biotechs, a trader willing to be long stock, effectively calling a bottom. I have a great background in both fundamental and technical analysis, so the options flow is used as the confirmation factor on my view to initiate a position, and when all 3 factors align I usually am left with the highest probability directional trades.
Since I have created a ton of tools and have a great memory I often do not jump into a trade the same day that I see the large trade, but instead will wait for the stock to either break past a key resistance level or fall back to a support level where I can enter the position at a better price than the "smart money". I always have past order flow in the front of my mind daily when scanning through stocks so I know which ones I want to get involved in. Over the years I have found that the large options order flow works out a lot more often than it does not, but the timing of the trades are rarely perfect, which can be said for most people, so it rarely is necessary to chase a trade right away.
Spreads — Many option traders are done in spreads with vertical spreads most common, but also see butterfly spreads, ratio spreads, 3 way spreads, risk-reversals, synthetics, and more. Overall the analysis is the name when determining how the spread is positioning. Hedging — A lot of Institutions use options to hedge and it is not always a perfect science when analyzing order flow, but you can put the odds in your favor.
Argus Focus List
First, if an option block trades as a fresh buy-write, synthetic, married-put, etc. I can determine this with the time and sales of the equity blocks. However, often option trades are hedging former holdings so there are a couple of factors I look at. If a stock is in a strong uptrend and I see put buying I am not going to automatically jump onboard as I can understand the desire to own puts to protect profits. And vice versa, if I see call buying in a name in a downtrend I often will wait for it to break above a key resistance level, unless I have a great fundamental reason town.
Also I always take into account the short interest and more specifically the recent changes in short interest. If short interest is climbing and I am seeing call buying I have less confidence in the action as the call buys are more than likely protecting short stock positions. Ex-Dividend — Liquid stocks will see heavy ITM call active ahead of ex-dividend dates in an arbitrage strategy often called dividend stripping. I cast aside this action as it is not directional and can only be efficiently replicated by large institutions.
Catalysts — One of the most important things to pay attention to is upcoming events that can cause a move so you can really dig into the reason of "why" the trade is being made.
Sometimes it takes a bit of creativity such as when Homebuilding stocks see unusual action ahead of New Home Sales or Pending Home Sales economic releases, or unusual action in Gold or Treasuries TLT ahead of a Fed announcement, or even names that will move in sympathy to other names that have upcoming events. It often takes a lot of research and digging, but is important to know.
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