The under-utilized tool that options traders must understand and use

Options flow data is a powerful tool that is not widely known about among retail traders and is most certainly underutilized. While it is a topic of discussion among many options traders, few know how to properly access it or utilize it within their trading. What is options flow data? Options flow data is the term for options data that is sometimes also referred to as the following: options order sentiment, unusual options activity, option sweeps, or simply order flow. All of these categories tie back into the same concept of what is generally described as orders from “smart money” (a.k.a. big players) in the stock market, such as institutional traders, prop firms, or market makers. These orders can range from anywhere between a few hundred thousand dollars, to millions of dollars. We will go over some examples of what these orders look like later in this article. 

Volume, as you likely know, is very important in technical analysis when evaluating potential direction of a stock. However, stock volume can be deceptive, noisy, or absent all together! If you are familiar with darkpools, you will know exactly what I am talking about. To quickly recap for context, darkpools are massive purchases of stocks that are hidden from the public eye in private trading exchanges. What does this have to do with options? Well, massive options purchases cannot be hidden in dark pools, and are readily available to the savvy options trader. 

Now that we have access to what the market makers and institutional traders are doing with options, how can we use this information to benefit our own trades? Options flow data utilization first begins with the mindset and belief that these big players in the market likely know something that we don’t. After all, you aren’t given a multi-million dollar bankroll to trade with if you’re playing a guessing game. Secondly, we must also believe that higher volume will lead to higher prices after seeing this flow come in. This notion goes against the grain of what I primarily teach traders, which is trading based upon supply and demand, or technical analysis. However, flow data often stands to trump the technicals. Simply put, options flow can suggest to us that a big move is coming. 

Here is just one example to illustrate the point: at 10:20AM EST on 7/5/18, there was an unusual options flow order for ticker $ATUS with a July 20th expiry 17.97 calls. The current bid / ask spread was .20 x .30, and the order was purchased at the mid price of 0.25 per contract. The order was filled for 2796 contracts! Let’s break that down. Someone had spent a total of $69,900 on these contracts which rarely see volume of more than a few dozen contracts per day. What happened within the next 20 minutes? Well, the stock exploded in price. Three hours later, the bid / ask spread was .60 x .70. With the assumption that this order was closed out at the ask, this trader’s initial trade entry of $69,900 is now worth $195,720. That is a gain or more than 100%! This order was presented to us with our options flow sentiment screener less than 2 minutes after the order was placed, as our stream receives live data (as opposed to 15 minutes delayed like many others). We had the opportunity to secure an entry at .30 when we received the notification. This is just one example - Many of the flow alerts we receive are of much higher value.

Now, you may think this is an anomaly, but it is not - Unusual orders like this are presented to us on a daily basis and can always yield profitable results if you so choose to take action upon the information that is presented to you. 

How is the information presented, and how do we decipher it?

We receive our data live from the exchanges (no 15 minute delay). That information is then processed and posted in the Thinktank automatically. The screen shown above from the Thinktank shows a handful of orders that came through on 7/5/18. The “Time” and “Symbol” columns should be self explanatory; these columns indicate what time the order was filled and what ticker symbol was used. The details column tells us the expiry, strike, direction (calls or puts), exchange it was traded on (in parenthesis - this information is useless to us), price the order was filled at, then the number of contracts purchased. The first entry from the above graphic would be sep21 expiry, 43 strike calls, PHLX exchange (again, useless info), 1.63 price the order was filled at, and 13500 contracts purchased. Following the details column is the IV column. This tells us what the implied volatility of the particular contract was at the time of purchase. Next up is the Market column. This column identifies what the bid / ask spread of the contracts were at the time of purchase. This information is very important - If the order was filled at the ask, it can indicate a “sweep” order in which the buyer purchased all of the available contracts at that time, or wanted the order to be filled immediately. Finally, we have the Underlying column, which tells us what the underlying stock price was at when the order was executed. 

We have setup our flow data to include any order that the exchanges consider a large options block purchase. However, all spreads have been removed from the stream. Knowing that spreads were not included in the stream is key information - many of the other order flow services do not distinguish between spreads or directional trades. Spreads only indicate to us that the buyer thinks a large move in the underlying is coming, but does not know what direction the move will be. By filtering out this information, we get a clear idea of the direction and the confidence level of the buyer! 

While most of these trades will most certainly end up profitable at one time or another - there are other important considerations that come into play when determining if you want to follow an options flow trade or not. For example, the traders that are putting on these trades will most certainly have different risk tolerance levels than you. Additionally, while you can gauge their timeframe (via expiry), you can not know exactly what their time frame or trade plan looks like. We also don’t know if a trader is hedging an underlying position with a large options order for insurance.

For these reasons, it is suggested to follow options flow trades with light size and to follow your normal risk management rules on these trades. Secondly, it is not recommended to follow every single trade that comes through - this options flow information is presented within our Thinktank for discussion among the members and as a means to potentially find additional trade ideas. With this in mind, a cautious approach and some quick due diligence, there is serious profit to be made with the options flow data.

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