Last week, the media were tripping all over themselves trying to figure out how Bed Bath & Beyond (BBBY) stock surged over from below $5 to above $25, a 400% gain. It subsequently collapsed back below $10, creating a few…
multi millionaires but leaving most poorer for the endeavor.
I won’t recap the malfeasance or the lack of diligence that led to this pump and dump, but suffice to say, we had bad actors and people that took an old 13D report from March, FIVE MONTHS OLD– as breaking news.
Options360 does it own work and doesn’t get lured into late “Breaking News…”
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I want to focus on what is dubbed as Unusual Option Activity (UOA). There are plenty of talking heads on media and services pushing UOA as a viable and reliable trading strategy. It is not. I worked at one of the world’s largest aggregators of option flow analyzing – bid/ask, size – and found most of it you can’t act on. A hint, maybe. A home run… rarely.
Using option activity as an indicator for impending price moves is difficult, subjective, and unreliable. That being said, it can help confirm other indicators and increase the probability of a profitable trade.
Indeed, there have been many situations in which activity in the options pits accurately predicts or presages an impending price move. There are 2 basic approaches: as a contrary indicator, or as a predictive.
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Contrary readings are predicated on the belief that prevailing investor sentiment is often wrong. Buy and sell signals are usually generated when readings hit extreme levels – such as a spike in the put/call ratio or the Volatility Index (VIX) – to flag a market bottom.
The predictive approach toward options activity says this information may actually reveal what the “smart money” is doing. Using options as a predictive indicator is more effective when applied to individual issues, rather than to broad indices or the market as a whole.
Here are some basic criteria for identifying meaningful activity and avoiding the chase for activity that ends up being useless noise.
Volume and Volatility
One of the first obstacles to interpreting unusual option volume is that, for every buyer, there’s a seller. It’s therefore important to decipher who initiated the trade. This can usually be determined by looking at the time and sales data; if most of the volume was done at the offer price rather than the bid, it’s safe to assume the buyer initiated the trade.
Look for an increase in trading activity and an increase in open interest. More specifically, the volume should be at least…
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