Developing a thesis that supports your options trades is important as you build experience and knowledge. Let’s go over 3 initial concepts that will be helpful when you start your evaluation of a potential trade and how they would apply when analyzing an unusual option volume signal.
Unusual Option Volume
As a trader, it is critical to have thorough tools to help you quickly find trade opportunities from the vast amount of data available to you. One such way is to scan the options market for unusual volume. This means that the current option volume, in a particular stock, is much greater than normal.
Extraordinary volume might be a technical signal for a big move in stock price and/or volatility, which, in turn, may present a trade opportunity. However, before you make a trade, there are 3 analytics you must evaluate. As a starting point, below is an abridged report of stocks exhibiting unusual option volume.
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Let’s take a closer look at some of the supplemental data of the first symbol on the list, OPAD.
1. Market Traders Lean – Calls or Puts
OPAD has a relative option volume of 6.5, which means that the current option volume is 6.5 times greater than its average daily volume i.e. it has unusual option volume. The report indicates that 75% of the volume was in the call options vs 25% in the put options. But volume alone doesn’t always indicate which way the market traders are leaning.
That’s why we must also look at the notional value to see if the dollar value of the trades supports the volume. In this case, there was $44 million worth of calls traded vs $9 million of puts. Therefore, we can conclude that the surge in volume is heavily favoring call options.
2. Catalyst Event
Whenever there is a lot of trading activity you should check for potential upcoming catalyst events. The stock might simply be reacting to such an event and shouldn’t necessarily be considered having unusual option volume. For example, stocks with upcoming earnings typically have greater option volume than normal.
However, in this case, the report is not showing any upcoming events (the columns for earnings and company events are blank). This is a good indication that something else is happening and we might still have a good trade opportunity on our hands.
Your next step would be to find any news and/or press releases that would justify the option volume, which would mean the stock is simply reacting to the news and isn’t presenting an opportunity.
3. Implied Volatility
You can determine how expensive an option’s price is from it’s corresponding implied volatility (IV). For example, the table above shows that the implied volatility for OPAD is up +21% on the day. This indicates that there are more buyers of option premium (the cost of an option over it’s intrinsic value) than sellers and means that, for some reason, traders are willing to pay more to purchase the option.
Furthermore, the IV percentage rank is 100%, signifying that the current IV level is higher than all the previous observations in the last year. This suggests that traders are anticipating higher volatility going forward.
These 3 factors are simply a starting point. Once you grasp these 3 basic concepts (volume, catalyst and implied volatility), you will be ready to do a deeper dive into the details of a potential trade. Stay tuned for the next article where we will show you how to analyze the option chain, time and sales data and open interest.