Options Trading Resources: Understanding Option Order Flow

In technical analysis there are only two primary things to watch, and that is price and volume.  Price is king and must always be respected, but money flow can give us clues to future price direction.  I look for where the big money is flowing, but unfortunately the information in stock volume can be a big noisy, deceptive. late or even absent.  We have all heard of the ‘dark pools’, where stock is traded in big size and secrecy (well, sorta secret) by institutions.  The public may not know about these moves for days or weeks, and that time lag could be the difference of winning/losing in a trade.

Options are different, there are not ‘secret’ trading rooms.  One of the best options trading resources I have found is the option order flow, or simply ‘the flow’.  These are not ‘backdoor’ trades and are seen off many different platforms, my preferred being the trade alert system/scanner championed by my good friend Henry Schwartz (see image.  Editors Note: Henry is a contributor to the CBOE OptionHub blog).  Henry’s scanner tells us where big option trades are being made, the size, type (buy/sell) and name.  It is the same information distributed by other services, but it’s about interpretation of the data and quickness for jumping on a trade that is most valuable.  You see, this puts me at the starting line with the ‘big money’ players, and if we can determine if the flow is good or not and capitalize on it, then we have an edge.

The flow is simple and basic but requires a belief that high volume leads to higher prices.  Without this notion in mind you will never be able to put it together with a trade setup.  While the chart / technical’s are also crucial we sometimes find the flow trumps the chart.  In other words, the big money flowing understands something big is coming down the pipe and does not want to be seen – well, at least not right away.  But we have to interpret the flow CAREFULLY, making sure we’re not chasing something that is not there.

Let’s take a look at just one perfect example.  In February and March there was some major flow in Kraft (KRFT), a stodgy old company with slow growth.  The chart was not giving any buy or sell signals, it simply was an avoid.  The flow we saw was focused on the June 67.5 call contract, 20K of these were purchased for about 70 cents in one day, and other days saw some good flow as well (but not as much).  Premium paid here was $1.4 million (20K x 100 x $0.70).  At the time the stock was in the low 60’s, so why would someone be inclined to buy this many calls at a strike far out of the money (more than 10% away from breakeven on these calls).

Well, if you followed this flow and rode along with this big elephant it paid bigtime – the deal announced with Warren Buffet, combining with Heinz had the stock soaring past 86 on that day.  Those 67.5 calls?  Yep, from a close they day prior at 40 cent to nearly 20 bucks.  The 20K buyer roughly scored a cool 37 million profit, and the options are still for another couple of months.

Now, this may seem the outlier, it’s just one example.  You wouldn’t be convinced unless you saw this happen over and over again, I get that.  So, you have a chance to learn more about it this week in my April 30 webinarhttp://tinyurl.com/lytw2vq I’ll be talking more about the flow and showing more examples, and some real time ideas that may work down the road!  Sign up for it with the above link, this will probably be full by midweek.

Bob Lang, Senior Market Strategist and trades various option trading newsletter “Explosive Options”.    Check out the updated site.