How to Monitor Unusual Option Activity

10/28/2013 6:00 am EST


Andrew Keene

President and CEO, AlphaShark Trading

Keep an eye out for stocks that are trading at four or even five times their usual volume and place your trades accordingly, says Andrew Keene.

SPEAKER 1:  My guest today is Andrew Keene from  We’re talking about how you monitor unusual option activity to make good trades.  Andrew, first of all, what do you kind of watch when you see unusual?  Let’s define it first.  What is unusual option activity?

ANDREW:  Okay, so the way that it trades there is 8700 publicly traded stocks, 3200 of those have options, so I work with a scanner that shows me a lot of trades across every single exchange, so I’m watching institutional order flow.  I’m watching hedge funds, mutual funds, retail bank, or big, big traders, so every single stock has stock average volume in a day, so maybe Apple trades 10,000,000 shares in a day.  If Apple was to trade 40,000,000 shares that would be four times usual volume, which would make it unusual volume.  Stock options are the same way.  Something like Bank of America probably trades 100,000 options in a day.  A company like TSO might only trade 10,000 options in a day, so when it trades expediential times than normal volume it’s known as unusual option activity.  The more times multiple, the more I keep an eye on something.

SPEAKER 1:  Alright, so you have scans that actually pick up when something’s up 20% in volume or what’s kind of your cutoff?

ANDREW:  I try to look at something that’s at least five times usual volume in a day.  My bread and butter is when I see a huge put seller.  Yesterday in CBG someone came in, they stepped in; they sold 10,000 of these 22 puts.  This is a bullish neutral strategy.  The stock was trading 22.65.  They sold these for a dollar, so they only actually hit the breakeven, on expiration was $21 but they will get long 1,000,000 shares of stock under that $22 level.  They’re just trying to collect that premium.  Yesterday we saw an interesting one in TSO.  The chart actually looked very, very weak.  Someone came in and bought 35,000 February 60 calls.  The stock is only trading $43, so this is an order that I see and then I place a trade based on their order, so they came in and they bought these February 60 calls for $0.50.  I just jumped onboard.  I bought the exact same ones.  I bought about $3000 worth of these calls and today actually the stock got downgraded.  The stock was down at reverse and now it’s up on the day and these calls are actually up in value.

SPEAKER 1:  How do you know if somebody’s actually just maybe buying insurance on an underlying position versus making an actual play on the price? 

ANDREW:  Yeah that’s a great point and you know options, and I always say calls are used for one of two reasons.  They’re used for speculation of upset or hedge against a short stock position.  Puts are used as a hedge against a long stock position or speculation to the downside, so my holy grail is when I want to see a huge put seller with X amount of times normal volume because 80% of the time throughout the decade of my trading from the CBOE, I’ve noticed they do not have a short position against short puts, so I look for a huge, huge put sellers usually.  Also, I look at calls, like TSO.  These are February 60s.  The Sachs 43, that’s not much protection.  The stock has to go up $17 and most likely they do not have a short stock position on against it, so that’s a great point of looking at these and deciphering which trades are good and what trades are a hedge against the stock position.

SPEAKER 1:  On a daily basis, how many trades do you find that reach five times normal volume?  Is it a lot that you have to then choose from?

ANDREW:  I trade a lot.  I think I have about 85 positions on right now, so you know it just depends on the day, like today was a little bit slower.  I maybe put on three trades today.  Yesterday I put on like ten trades, so I’m always monitoring.  I’m taking profits on these as they work out.  I bought TSO.  I bought these calls for 50.  I already am offering some at 70, which is a 40% profit if I get filled, so I’m always offering them out for profits, letting some of the profits run as well, so on an average day I would say there’s 20 trades out of 2000 that are worth looking at, and then I personally with my own money play six to ten of them.

SPEAKER 1:  Of that 20, six to ten, what are you looking at?  Is it just the biggest changes or kind of what creates the difference?

ANDREW:  My criteria are the first thing I look at is the volume versus open interest, so I always want to make sure the volume is greater than open interest.  That means it’s an opening position, not a closing position.  The next thing I always look at is I want to see the open interest across the whole board, so yesterday in TSO this was the biggest order on any strike, any expiration, so that makes me want to put on the trade a little bit more, and then I look at the chart.  If there’s a bullish chart and the activity is bullish then I will put on a trade.  Yesterday in TSO the chart was actually very, very bearish, but I still put on the trade, so I want to make sure the chart line is up.  When I have all those criteria I can put on a risk versus reward setups.  I never sell calls naked, don’t sell stratos naked.  That’s blowout risk, okay.  I’ve blown out before as a trader.  Thankfully it was about eight years ago, but I don’t want to blow out anymore, so then I put on a risk versus reward setup based on the hedge fund trading.

SPEAKER 1:  Andrew thanks for your time.

ANDREW:  Thank you.

SPEAKER 1:  You’re watching the video network.

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