Chesapeake Energy Corporation (CHK) is an oil and natural gas production company engaged in the development and acquisition of properties for resource extraction. The company also has marketing and oil services operations.
CHK stock closed Friday’s trading session at $28.28, and shares of CHK have traded in a 52-week range of $18.92-$29.48. Despite a recent slide the stock has been very strong over the past month, with shares rallying more than 6.3% in this period. As the stock touched new 52-week highs during the April 24 session, large blocks of bullish options spreads were bought in CHK. A trader bought 35,000 of the CHK Oct 35-40 Call spreads for a net debit of $0.41. This trade required the individual behind it to invest over $1.4 million in premium.
This order is considered ‘unusual options activity,’ and trades like this in the options market can be used to spot institutional money flow. This information is useful for several reasons.
The ability to spot trends in order flow can give traders insight into the investment activities of the biggest market participants. Options traders can also use unusual options activity as a leading indicator for potential moves in equities. These orders warrant our attention because the institutions executing them have better access to capital, information, technology and larger teams performing analysis. Options trades generally fall into one of two categories: hedges or speculation. When tracking unusual options activity, a trader must determine is whether the order in question is a speculative bet or a hedge. Traders only want to follow speculative bets, and there are several ways to determine if this is the case for a given order. The first method is to determine the technical strength of the stock.
Technical Strength In CHK
Although shares have fallen from their recent highs, technically CHK is still quite strong. The stock continues to trade well above the Ichimoku Cloud, a forward-looking indicator used by traders to determine if a security is trading in bullish, bearish, or neutral territory. When this order block hit the tape, CHK was trading well above the Ichimoku Cloud as well as all the major moving averages. The stock also carved out a new 52-week high on the same day. With the stock setting up so strongly on the chart, it seems unlikely this order was placed to hedge a short stock position, but instead was a speculative bet to the long side. When analyzing order flow, traders must use technical analysis to determine the likelihood that a block trade is (a hedge) against an underlying stock position. Most often, a bullish trade hitting the tape when the stock is in bullish territory is a speculative long, whereas a bearish trade hitting the tape when the stock is in bearish territory is probably a hedge. By applying technical analysis, traders can determine whether an unusual option activity order justifies following with one’s own risk capital. Options statistics can further assist in making this determination.
Options Statistics in CHK
Traders can also compare the block orders against options statistics. For example, in CHK we can look at the total open interest put/call ratio. This shows in what lines open interest is sitting, and if there is a bias towards put or call buyers. This ratio is calculated by dividing the number of open puts by the number of open calls. On the day we saw CHK call spreads being bought, a clear bias can seen when looking at this ratio. On this day, the total open interest put/call ratio was at 0.58. This indicates the majority of open interest is in calls, and an overall bullish bias in terms of options demand. Thus, there is an increased likelihood of this trade being a bullish bet.
Filter Out False Signals
While technical analysis and options statistics can be used to filter out false signals entirely, when properly applied they can greatly increase one’s odds of successfully trading unusual options activity. Reading order flow for unusual options activity is one of the best (if not the best) ways for traders to see what ‘smart’ money is doing. Put another way, this can level the playing field between institutional and retail traders. Unusual options activity allows for retail traders to benefit from the ‘edge’ held by institutions, and is incredibly valuable when interpreted properly.
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