Rarely in trading do all the stars align.
But when they do, you feel unstoppable. And usually end up with quite a profit at the end of the day too.
Identifying unusual option activity is important. But once you do, it’s even more important to identify all the individual parts of it to see just how big of an opportunity you’ve found.
Think of it like a recipe.
If you skip an ingredient or two, it might not make for a bad meal. But if you include each and every ingredient and mix them well, your meal will taste a whole lot better.
The same is true with trading. Specifically, finding and including all the ingredients into a perfect unusual option activity alert.
When all four of these factors line up, you often come up with a true market-beating opportunity.
1. Options Volume
The first thing you should look for when trying to find unusual option activity is obviously the activity itself.
You don’t need expensive trading platforms or high-frequency trading computers to see how many shares or options contracts trade on a particular security.
Anywhere you can find option prices, you can find how much volume each strike has traded that day.
This is important because it lets you compare it to what that contract normally trades, or its average daily volume.
If you see a particular contract has traded well above, say three times or more, its average on a specific day, that’s a good indicator that something is going on.
The larger the volume, particularly the larger jump in volume compared to its average, the high probability some big money has moved in.
When that happens, it’s not usually a random bet. Chances are big money like that signals some inside knowledge of an impending move.
2. Option Open Interest
Like the first, how many open contracts there are for a particular strike is a big signal. If there are only a few, chances are there’s no big money moving in.
But if you see a jump… or you see the volume for a specific contract spike much higher than open interest, that should alert you to an opportunity.
Someone knows something about a potential price movement and is putting their money down at a higher-than-average rate.
3. Implied Volatility
This is one of the most important indicators every options trader needs to know. It’s the main reason why so many get burned using options.
Implied volatility (IV) reflects the market’s expectations for future volatility. Implied volatility is dynamic and fluctuates according to supply and demand in the market.
When there’s strong buying demand for the options contract, that drives up volatility and oversupply drives down volatility.
There's more to this than we can cover today, but when implied volatility spikes higher, it's likely the contracts were bought.
Buying into that move can yield quick profits if done right. But it can also become a headwind.
As demand for those contracts ease, the implied volatility will come back down.
When that happens, the cost of the option will fall with it.
So, it’s important to keep an eye on implied volatility and which way it’s headed.
4. Amount Traded on Offer
This final ingredient for a perfect unusual option activity alert is just as important as volatility.
If you’ve ever haggled over the price of something, you know this idea already. If you are trying to buy something that you absolutely need, you’d probably pay whatever the person selling it wants.
The same is true in the options business. Contracts are only traded when the buyer and seller come to terms on a price.
This is the spread. There’s the “bid,” which is how much the buyer is willing to pay. And then there’s the “offer,” or how much the seller is willing to accept.
When a high number of trades are executed at the offer price, it indicates high demand for that contract.
It’s a simple and clear way to see just how important that contract is to buyers. They want in even if it costs a few more cents per share to get it done.
These four ingredients make for an ideal setup for a trade.
If all four are present and are clearly identified, you know before you even make the trade that it could be a winner.
Be sure to check each of these before you put any money down.
There’s no 100% foolproof way to always profit from every trade. But being able to identify these pieces of the puzzle is definitely where you need to start.
All four of these triggers is how I use my 3 Ways to Identify Unusual Option Activity
Here's to living rich,
Joshua M. Belanger