Unusual Option Activity - Trace the footstep of WallStreet "smart money"

TradingFlow Joey
April 13, 2022

Unusual option activity by definition occurs when an option market of single equity or other underlying asset observes unusual trading flow in a short time scope.

In general, unusual option activity can be classified into block and sweep:

Block is a single order with abnormal high trading volume than average level. Blocks can be counted both by dollar value and contract size. Different trading platforms, information providers and individual traders might have slightly different methods defining the threshold volume and referred trading timeframe. The situation can also vary on different equity objects. Generally, a block is confirmed when a single trading volume accounts for over 5 times of last 30-day average exchange volume for all option markets of the underlying equity. The catalyst of a block is a real hurry and strong money flow to get fill by market players. Those market players are often big institutions or we called “insiders” who have relative edge over trading information, money pool, and algo system.

Sweep is the other type of unusual option activity as trading order spread on multiple exchange markets. A sweep is typically a large order that is broken into a number of different smaller orders that can then be filled more quickly on multiple exchanges. A sweep order instructs the broker to identify the best prices on the market, regardless of offer size, and fill the order piece-by-piece until the entire order has been filled. The catalyst for sweep orders is to hide intention from the executer and make those orders stay “irrelevant”. This can be also a track of smart money who might be certain on the next day market volatility with edge but would not like to be radared. The other aim of a sweep may be taking as many as available contracts at the best prices, which indicates an aggressive bet on the underlying asset market. Traders choose to make sweep order as the trading cap of a single exchange is not able to fulfil their position. Let’s take a dip into a sweep order captured by our platform on 28th February. In the order details, it shows a trade count of 9. In other words, the order is executed in 9 different exchange markets with total volume of 1500 lots. If we are not able to radar those orders from one single source, these orders might be casually taken as irrelevant small orders without hint.

Figure 1: A sweep order on OPRA 28th February  

·        Why is it valuable to study UOA?

We’ve already touched a bit on the reasons for using unusual option activity as indicative trading information. One major trick in playing directional or trend tracing trading games is to find hints on market power imbalance to instruct possible direction on future trend. Stock market appears no difference than food market. Price movement or market volatility is always driven by imbalanced relative strength between supply and demand. Different market players with different magnitude of money flow have varied impacts on the markets. Bigger fishes or as we called “smart money” compared with small fishes have natural edge to drive the market direction with stronger relative strength. The edge can come from inside information, smart heads, rich support from research department, and fund resources. Unusual option activity helps us find where the big money comes from, and possibly identify their position or intention on the market. Although the underlying intention might not be obvious or aligned with bet direction, we may not read directly from the action of big money or get definite trading signal merely from unusual option activity. Moreover, the power fragmentation can be higher than we expect in a market with adequate liquidity that it is hard to say one single party or big order can have significant impact on the market. Nonetheless, unusual option activity can still be trading reference or raw factor we can integrate together with other signals in our system to build a more effective strategy. Even if in a non-directional trading strategy such as betting on implied volatility, unusual option activity can also help us trace the big money flow and learn from their methods.

·        How to read catalysts behind UOA?

It is worth noting that not every unusual option activity can provide us with useful information and trading signals. On the contrary actually, most of the unusual option activities might be jumble mess without indication. They can also be hedging from large long-term investors rather than a directional view on the market. The hedging can come from market markers as a tool of risk neutralization when the market liquidity is limited that profits from spread are swollen or big clients overwhelmingly bet on one side. To avoid directional risk exposure, market makers may take option as hedging method in response. Hedge fund and large investors can also use option to protect short-term pullback risk and increased volatility in their longer-term bets.    

Compared with single block, tracing options flow may provide us more valuable information. We can read catalysts behind UOA in detail from the following aspects:

Be careful with bullish puts and bearish calls. Put flow that comes in BB means the order is traded below the bid. We all know that put flow in ask is bearish as the trader is betting on price drop. However, put flow in bid especially when below the bid is bullish as it shows the strong intention from the trader to get out of short position. In other words, it should be a sign of bullish market. Put flow that comes in AA (above ask) similarly should be considered as a stronger bearish sign than put in ask, showing the trader is willing to take higher ask price in a short position as soon. Following the logic, call flow that comes in BB is bearish (strong will to sell long) while call flow that comes in AA is bullish (strong will to buy long). The underlying assumption of the logic is that investors tend to hold their position and let the profit flow if they are sure that current trend will sustain.

Figure 2: Example of AA and BB contracts on TradingFlow  

Don’t mix up between long-term dated bets and short-term ones. It is tacit that intraday traders never look back on price movements happened a month ago unless the impact is proved to be sustained. Traders using higher time frame and lower time frame should stick with their separate time setting, and the rule also applies in option market. If we are short-term traders and observe a near-term expired option flow mixed with long-term dated ones, we should cautiously assess the impact of longer-term dated contracts as they may come from traders using higher timeframe signals or technics. A trading range on a higher timeframe can appear to be a strong trend in lower timeframe, therefore it is important to figure out accurately who you are betting against.

It is also helpful to distinguish between opening and closing orders. A closing order is simply an order aims to close past opening position or simply just because that the contract is due to expire. Compared with a closing order, a net opening order happens when the volume of a trade surpasses the current opening interest. Opening order shows new interest on a directional bet from the trader and thus is considered more indicative than a simple unusual option activity without higher volume than open interest.  

Figure 3: Examples of UOA with opening position  

Constant flow formed by sweeps and blocks on a single ticker throughout the entire day can be one kind of good unusual option activity signals, especially when the flow comes in same strike, same expiration, and climbing contract prices (in bullish call setting). Even if the separate score of single sweep or block can be low marked by AI system, the combined option flow tells a more compelling story that big money is stepping into the market gradually to pool in the troop. It can be a hint on future relative strength switch between supply and demand on the market.

Figure 4: Example of constant sweep flow  

Be careful with UOA within short-dated OTM contracts. Significant volume in OTM options is suggesting that some big money is betting on short-term volatility that possibly a big move is expected in a near term. Here is an example of two UOA orders of FLR stock. Compared with the first order, the second one has shorter contract length with nearer expiration date. Two orders hold fair volume while the second UOA may be more indicative to short-term market moves.

Figure 5: Example of UOA within different term-dated OTM contracts  

Filtering out the unusual option activities with hedging catalyst, we could list a few major possible underlying event drivers in relevance. They can come from technical perspective and fundamental news such as:

-         UOA happens ahead of seasonal financial report release

-         Abrupt event that has an impact on revenue generation or major business operation of the company happened such that a new product launch is soon to be announced in public, merger and acquisition

-         Influential rating institutions upgrade or downgrade the equity

-         Market is moving at a key technical price level (multiple MA Crosspoint, daily/monthly S&R, key Fibonacci pullback level, or simply a trading range with scalping and volatility opportunities)  

This article is a general introduction on the concept of unusual option activity as what is UOA and why it is important. Do bear in mind that UOA is trading information serving for our own trading system rather than compete strategies we could directly use. UOA has to be carefully analyzed and selected. The advantage of option market over dark-pool equity is that option activity data is publicly accessible with all trade flows and orders can be traced. It is also the major aim of our Trading Flow platform to provide instant first-hand option market data with optimized trading facilities to assist with individual traders. The AI algorithm of the platform also produces processed multi-dimensional information as further reference. Welcome to TradingFlow for more updated option trading tools and information. In the following articles relevant to option market, we will touch on more aspects of option knowledge and trading. We may also further introduce how to select and utilize high-quality UOA integrated with other trading techniques to improve our edge in the market and to help build your own trading system with improved success rate.

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