Over the past 18 months or so, I have discussed Unusual Option Activity (UOA) at length. My analysis, quite frankly, has not proven UOA to be any sort of panacea. Should I just ignore it? I don't think so.
Like most things, the truth is not clear cut. I have proven, at least to myself that blindly following UOA is a random walk at best. But there are instances where it can lead to something more compelling.
Let's start with an assumption that there is an instance of UOA where someone is selling new positions in puts. This is most likely one of two things: 1) they have no position and want to take a position at a lower price level (stock replacement) or 2) they are not short the underlying. If one is shorting the underlying, typically one is not selling puts against it. It doesn't make margin sense to approach things like this. So, given that the position is sufficient in size (5x average daily volume), this could be a piece of evidence that this is a bullish signal. This is especially true if it makes sense in a technical analysis framework.
A Specific Play, Highlights
As traders, we want to put as many contributing factors as we can in our favor when generating a signal. Will it always work? Heck no. Will it work over time? My 20+ years of combined experience says so. Let's take a look at my signal long in the November FB 77.5/80 call spread. In general, my fundamental outlook on FB remains strong. It continues to be one of, if not the, go-to outlets for social media across broad sectors of the global population. From the technical side, it found support at the 73 area. This is another bullish indicator. Here is what Bloomberg News has to say about it.
As many as 178 million shares, or 8.8 percent of Facebook’s outstanding stock, may enter the market as a lockup on stock sold during the acquisition expires, according to Goldman Sachs Group Inc. analyst Heather Bellini. “The shares could become available for trading in the two or three days after Facebook reports earnings on Oct. 28”, Bellini said.
So, the market knows (and thus has priced in) a nearly 9% dissolution of the stock. The market absorbed this news (another bullish signal). Using the implied volume going out to the November expiration, I see the market is pricing in an 80.50 level to the upside. I identified the November 77.5/80 call spread for $0.50. This has a reward to risk ratio of over 9:1. That is called leverage!
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