Bet on Implied Volatility

11/20/2013 6:00 am EST


Andrew Keene

President and CEO, AlphaShark Trading

By looking at institutional order flow, Andrew Keene is able to bet on implied volatility. Here he shares this new strategy and how it can help your options trading.

SPEAKER ONE:  Well as a trader you are always looking for new strategies that work.  Our guest today is Andrew Keene from to talk about one of his strategies he looks at.  So Andrew, I know if you’re an option trader if the stock is not doing so well, you maybe have seen some activity in the options that actually make you think it is time to make a trade there.  What are you looking for? 

ANDREW KEENE:  Yeah, I mean the big thing I look at is institutional order, so I’m watching hedge fund, mutual fund, retail banks or big traders, okay, and I want to see what they are doing, okay, and I have to realize that not what they’re doing is going to be directionally biased, but it also can be a bent on implied volatility.  We had an example in UPS where a trader came in, bought $70,000 when UPS was trading around $91 of the January 2015, the 110, 120, bull call spread for 70 cents.  This was a $5 million abet in UPS.  They were risking $5 million to potentially profit around $45 million on this bet, so this is a huge, huge bet.  Also when they’re buying premium in 2015, it’s also an abet on implied volatility, so usually when an institutional order comes in implied volatility is just a supply and demand curve, just like everything else in this world, it’s a difference of what person is willing to pay and one person is willing to sell it for.  You can use historical volatility with implied, but implied is just a supply of anchor.  Then within days, UPS actually sold of $2.  The trade I put on, I bought the 110 calls for 90 cents.  I didn’t need to sell the 120 calls for 20 cents.  I figured just buy the one or get those for 90 cents.  Within the next two weeks, UPS actually sold off $2 and the calls actually went up in value, and you think to yourself well calls are bullish, how do calls go up when the stock goes down?  Because implied volatility goes up.  A couple of days ago, they came in and they bought 70,000 more of these spread, so implied volatility has actually gone up and I actually sold some of these for like a 25% profit as the stock sold off $2. 

SPEAKER ONE:  And are you taking the exact strike priced and the exact expiration month as these big traders are?

ANDREW KEENE:  It depends on the trade, you know that one per se I did, but I looked at the trade and I said they bought the 110s for $90, they sold the 120s for $20.  I don’t  need to sell those 120s for 20 cents.  After commissions, I’m going to pay another penny on that and then I can’t get out of the trade so much, so I will just buy the 110s.  Another example was in TSO, a trader came in and bought $35,000 TSO February 6 calls.  The stock was trading $43.  I look at this and one thing I always look at too is cash outlay, how much money are they putting at this bet, and $35,000 of these at 50 cents was about a $1.7 million bet, so this could be activists, or Carl Icon or David Einhorn, someone’s taking a huge, gigantic bet on this.  Do I go out there and put all my chips in one basket and do the exact same thing?  No, but I’m willing to risk a percentage of my capital on this trade, so I went out and bought these on TSO and once again, if a hedge fund is buying calls, their Greeks are Long Delta, Long Gamma, Short Theta, but then again, Long Theta.  They are buying implied volatility, so these calls actually went up in value just because supply and demand curves take some of these calls up. 

SPEAKER ONE:  Now I know a lot of big traders hate to show their hand and show that they are buying these big positions.  Do they do things to try and hide this sometimes, but you can still kind of see what they are doing? 

ANDREW KEENE:  Well absolutely, a couple of months back, about six months ago, they did trades in HNZ and what they tried to do when the buffer came out and the stock went from 60 to 80, they tried to sprinkle their bets off, like 200 allowed in this exchange, 300 on this exchange, so it is very rare for you to see a huge order that’s that big in one chunk, but it does happen.  If they wanted to kind of disguise themselves, what they will do is they will do smaller orders and spice it off a couple days, mostly because something like TSO.  If the news comes out today and the stock is up $5, that is a red flag.  Another thing the hedge funds can do because they have gotten a lot trickier and mischievous in their age right here, they can buy puts and they can buy stock, because what that is is a synthetic of a long call.  What they do a lot of times it actually happens when they buy puts the stock goes up and you’re like, how do they make money?  Well they’re actually lawing the stock as well, creating that synthetic, but then when the SCC comes to them and said you made all this money because you’re lawing the stock, they can say hey, but I’m on all these puts and I lost money in these, so the hedge funds have a great way of disguising their positions sometimes.  This one was great writing on the wall, so I jumped on really quickly, really fast, but you know, you’ve got to take into consider that it takes a long time to realize what they’re trying to do.    

SPEAKER ONE:  Andrew, thanks for your time. 

ANDREW KEENE:  Thank you.

SPEAKER ONE:  You’ve watching the video network. 

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