Simply buying or selling options based on unusual options activity is usually not enough of an edge to be consistently profitable in the market.
However, using unusual options activity as part of your process, is great tool for filtering underlying stocks and figuring out what the smart money is doing with their capital.
They say when something is too good to be true-it probably is.
These are the ones I always struggle with, because I tell myself, Josh it's not that easy! Here's one of those examples that fit that too good to be true description.
The stock I'm talking about is Digital River (NASDAQ:DRIV)- and we are going to flashback to the trading day of October 6, 2014.
(Data Source: Activ)
The above chart tracks option volume in DRIV from 8/1/14 to 10/06/14. (you can access this with the software I talk about in The SIZZLE Method Report)
The big green bar represents the size of the call volume on October 6th in comparison to the last several weeks. In fact, around this period DRIV, traded on average 75 contracts per day. On October 6th, it traded over 2,200 contracts…with the majority being calls. This was nearly 29 times the amount expected to trade that day.
Now, unusual volume alone is not enough, but when it is focused and there is a clear indication of buyers or sellers, we can use that information to our advantage.
(Data Source: Activ)
The majority of the action was in the November $15 and $16 call options that had about a month (of life) before they expired- the stock was trading around $15 per share.
By observing the time and sales and how these options traded, we're able to pick up a lot of information. For example, the majority of the call options traded on the offer side. That means that the trader was a buyer. In addition, the volume was greater than the open interest. This tells us that this was an opening position or a new trade.
Just with this information alone, it's not crazy to assume that the buyer of these options was speculating for a move higher in DRIV, before or around that November expiration period.
Why Are They Buying These Call Options?
Well, we never know for sure, we can only speculate on the reason. Looking at some recent news, on 10/06 they announced that it entered into multiple payments agreements with Klarna, a Stockholm-based payment provider.
Without having further knowledge of the situation-one would think the news release was bullish for the stock- and the reason why a large investor was interested in the name.
However, that was just the beginning. It was followed by four more days of this type of call buying. Someone was shelling out a lot of capital, speculating for a large move to come- and in a very short time.
(Data Source: Activ)
On October 8th, you'll see in the above chart, that over 8,500 calls traded. For this underlying at the time, that was 32 times usual amount of options expected to trade.
This time, we saw one single order of over 3,500 November $18 calls bought on the ask side for $0.55. We know that this was a new position…because this was done against zero open interest.
The underlying was trading around $15.99 a share-the trader buying these calls was playing for prices to move higher- very quickly- or trade above $18.55 by expiration (which was just weeks away)
(Data Source: Activ)
Let's break this down so it's easier to understand.
A large trader/institution is betting that DRIV trades above $18.55 by the November expiration period. That's nearly a 14% move-just to break-even!
Because they bought options, their risk is limited to the amount of premium they spent.
In this five day buying spree of options…the stock moved from $15 to $18. Also, implied volatility increased over 70%. During this period, the spike in option volatility caused the premiums to become more expensive, which made the break-even point farther away.
- unusual options activity for five days
- relatively near term call options are being purchased
- implied volatility is rising everyday, yet more and more options are being bought.
- not one single strike or contract month is being bought, call contracts in October, November and December bought.
Coincidently, these comments were made on 10/08:
"Piper Jaffray recommends owning shares of Digital River for catalysts in 2015 and believes the return to revenue growth in the upcoming September quarter will drive shares higher. Piper expects the company to add new branded manufacturing categories, including luxury goods, sporting goods and power tools, in 2015 and reiterates an Overweight rating on Digital River with a $22 price target."
As you can see, there were a number factors leading towards having a positive sentiment in the stock. However, even with that said-was there more going on?
On October 24th, this news hit the wires:
Digital River announced that it has entered into a definitive merger agreement to be acquired by an investor group led by Siris Capital Group in a transaction valued at ~ $840 million. Under the terms of the agreement, Siris will acquire all of the outstanding common shares of Digital River for $26.00 per share in cash.
That morning DRIV stock price gapped 48% higher…all those call buyers were rewarded nicely.
Those options that were bought to open for $0.55 traded above $5 per contract. As mentioned earlier, this was one of those too good to be true trades…however, it worked out.
In The SIZZLE Method Report, I teach you my process, how to filter unusual option activity orders and find those diamonds in the rough. I made it to be a quick, step by step approach, on how to use unusual options activity to generate trade ideas. Every now and then…you'll be able to find home run opportunities like the one mentioned here.
In addition to The SIZZLE Method Report, you also receive a free, 30-day trial to the same unusual options activity scanner that I've been using for years. Actually, the images used in this piece, are from that software. Not only can it be used for research, but it also runs a real-time options flow scanner.
If you haven't picked up your copy of The SIZZLE Method Report yet, you can still access it and a 30-day free trial to the unusual options activity scanner for a great investment of $10.
Now it's your turn, what do you think about unusual options activity like this, useful or not?
Even though I missed this one, a few that I've taught over the years and learned my method from The SIZZLE Method Report on how to spot this type of activity were able to participate on a few contracts.