Options Flow trading has gained popularity in recent years, with various sites and tools attempting to capture and analyze the data. For multiple years, options flow data and option sweeps were something that we tracked in the Trader’s Thinktank. However, after tracking this data for 6+ years, it's clear to me that options flow and option sweeps have lost the edge they once provided. There are significant reasons why following the options flow is no longer worth your time. Here's why:
Inaccuracy of Automated Scanners
Many automated scanners and alerts claim to provide real-time Options Flow data, but their accuracy is questionable. Relying on these tools can be risky, as they often misinterpret fill prices compared to bid-ask spreads. Additionally, advanced trading firms have become adept at disguising their orders, making the data even less reliable.
Flaws in Understanding Trading Strategies
These tools often fail to grasp the nuances of trading strategies, including spreads, stock-tied positions, adjustment trades, and opening versus closing positions. This lack of understanding can lead to misinterpretation of data.
For example, we often see traders posting online whenever there is heavy options activity in VIX. It's not uncommon to find institutional investors employing complex strategies that involve shorting junk assets with the expectation of their value plummeting to zero while simultaneously purchasing calls as a form of insurance. This behavior is akin to what we observe with the VIX (Volatility Index).
Institutional players often short the VIX during bull markets, essentially betting on prolonged market stability. They complement this strategy by purchasing calls, which serve as a hedge against unexpected volatility triggered by news events or unforeseen market shocks. However, it's crucial to emphasize that these calls are not necessarily indicative of a bullish outlook on the VIX itself.
The Importance of "Why" Over "What"
Tracking options flow should be about understanding the reasons behind the trades rather than blindly following what's happening. Determining the catalysts, combining technical analysis, and exercising patience for optimal entries and exits are crucial aspects of successful flow tracking.
The thing is, by the time you have done that analysis, the options flow is usually not giving you any advantage over what you would have found directly on the chart. As a trader, you want to base your analysis on something that is concrete… And one of the only absolutes that we have in the market is price and volume.
Smart Money Trades Are Sub-optimal
While smart money trades can be intriguing, they often have sub-optimal entry and exit points. You never know how much risk the “smart money” trader is taking, how they’re entering the play (could be in multiple orders), whether it is a quick flip, a swing, or just buying protection for a larger stock trade.
In conclusion, while options flow trading has its merits, it's essential to approach it with caution and a critical eye. These days we are seeing options flow that is noisy and misleading, and blindly following it can lead to losses. Instead, focus on understanding if there is something within price action on the particular stock that you may have overlooked. That said, less is more when it comes to trading, and simplicity wins - Personally, I was no longer getting any benefit to my trading edge from using flow data, so I stopped using it and it is something that we no longer focus on in the Trader’s Thinktank.