Like it or not, the trading floors are not much more than live-action museum exhibits now. Sure they exist, but barring a few niche markets, the real action takes place electronically. This is not necessarily a bad thing. The electronic markets give us insights in real time that we simply did not have in the past. Large orders would go down in the pit and it was like one of those games of “telephone” we played as kids. What just happened? Who did that order? How many did they do? Your ability to answer these types of questions was directly related to how close you were physically to the order. We literally had to wait for the next morning when we saw the volume/open interest reports to truly confirm what we thought happened. Now, we have real-time data of what happened. We can use this data much like the “insiders” (those close to the activity) to our advantage now.
We call this unusual option activity (UOA). It’s pretty intuitive that large orders tend to move markets both from a directional and implied volatility. We can use UOA to act as a leading indicator to a signal entry. A large order in and of itself does not necessarily mean that it is actionable for a trader. A large order may occur for a number of reasons. It could be a hedge for a major shareholder or it can be part of a buy right, etc. I need to be a bit more of a detective before I act on UOA. The time frame needs to be considered.
Is the investor purchasing options that expire in 6 months? A year from now? If so, it really doesn’t give us a clear signal that something is perhaps going to happen soon. Another consideration is sector. If it is in a sector where discrete, binary events are likely to occur like pharmaceuticals, biotech, etc., it is more significant. Also, if a new position is established in a weekly option it really gets my attention. Something with an expiration of one or two weeks really can’t be a hedge. It just doesn’t make sense to protect yourself with such a large bet for such a short period of time unless there is something like an earnings play in that time frame.
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