Understanding Unusual Options Activity (UOA)
Before delving into why UOA may not be a reliable strategy for consistent profits, it's crucial to understand what unusual options activity (UOA) entails. UOA revolves around the trading of option contracts at volumes significantly higher than their daily averages. The allure of UOA lies in its potential to uncover market insights and potentially ride the coattails of informed traders -It is data that we tracked and traded with for a number of years in the Trader’s Thinktank. However, as we'll explore, this approach has lost some of its luster.
The Anatomy of Unusual Options Activity
Unusual options activity is characterized by several key elements:
High Volume: The daily volume of an option contract in question far exceeds its average, sometimes reaching levels five to ten times higher than usual.
Large Concentration: Often, a substantial portion of the daily trading volume for a specific option contract can be attributed to a single, massive trade. This concentration suggests that someone is making a significant bet on the direction of an underlying asset.
Expiration and Strike Price: Unusual options activity is frequently associated with options contracts that have short-term expirations (such as weekly options) and strike prices significantly out of the money (OTM).
Why UOA May Not Be a Reliable Strategy
While UOA may seem like a promising strategy, here are compelling reasons why it may not be the most dependable approach for consistent and profitable trading over the long term.
1. Inaccuracy of Automated Scanners
Automated scanners that claim to provide real-time UOA data can be unreliable. These tools often struggle to accurately interpret fill prices compared to bid-ask spreads. Moreover, seasoned traders have become adept at disguising their trading intentions, adding another layer of complexity to the accuracy of the data.
Disingenuous reporting of an unusual options trade from a popular retail scanner
Many of the popular UOA scanners love to highlight trades (see screenshot above) that have come in prior to some news event. They wait for the news, they look for some “unusual trade” that fits the narrative, and then they share how much that trader potentially made. While this might be a good strategy for generating to subscribers to the service, it is disingenuous. There are thousands of these unusual trades that come through on a daily basis, many of which generate absolutely no profit. It is common for these UOA scanners to share these data points implying that a retail trader could have caught that trade. Let me be the first to tell you that it is impossible for retail traders to track them all and know which trades will work. It is a strategy that is more akin to gambling than it is to trading. If that is what you are in the market to do, be my guest. At Opinicus, we are focused on educating traders to develop long-term profitable systems.
2. Misunderstanding Complex Strategies
UOA tools may lack the sophistication to comprehend intricate trading strategies. They might misinterpret spreads, stock-tied positions, adjustments, and the differences between opening and closing positions. This inherent limitation can lead to misjudging the intentions behind trades.
For example, heavy options activity in a specific stock may not necessarily indicate a bullish outlook on that stock itself. Institutional investors often employ sophisticated strategies that involve shorting assets while purchasing calls as insurance against unforeseen volatility. Understanding the "why" behind these trades is as critical as recognizing the "what."
3. Prioritizing "Why" Over "What"
Effective options flow tracking should focus on understanding the motivations driving trades. It requires analyzing catalysts, integrating technical analysis, and patiently awaiting optimal entry and exit points. However, this analysis can be time-consuming, and by the time it's completed, the options flow data may no longer offer a substantial advantage over straightforward chart analysis.
In trading, concrete factors like price and volume remain paramount. Relying on these fundamentals often proves more effective than chasing after elusive options flow data. Remember, only price pays.
4. Suboptimal Smart Money Trades
While smart money trades may appear alluring, they often come with suboptimal entry and exit points. It's challenging to gauge the risk undertaken by these traders, their trading strategy nuances, and their ultimate objectives, whether a quick flip, a swing trade, or a hedge against a larger stock position.
Conclusion: A Cautionary Perspective
In conclusion, while UOA initially seemed like a promising strategy, it has become increasingly noisy and potentially misleading. Blindly following UOA can and usually will lead to losses. Instead, traders will benefit more from focusing on understanding price action and volume dynamics within the stocks they are interested in. Simplicity often prevails over complexity in trading.
With almost a decade of trading experience, I can tell you that relying on price and volume analysis, rather than chasing elusive options flow data, can provide a more consistent, effective, and profitable approach. In a trading landscape where noise can drown out signals, a cautious and critical perspective is essential when considering unusual options activity as a viable long-term strategy.