Every now and then we are looking at trades and see some unusual and abnormally high options trading volume. But how can you really profit from this high volume? Moreover, why is there high volume in just a few strike prices? Either way, high option volume is usually staring you in the face when you see it.
Under the right conditions high options volume can tip you off to some potentially explosive moves in individual stocks. Of course these don’t always happen, but when you see high volume you need to know what to do next…
There are usually only 3 main reasons for high option volume:
- Upcoming News. Do you see any kind of hint, rumors, about anything that might have a major effect on a companies earnings potential in the near future? Maybe a new product is going to be released or approved. Whatever the case, it’s a big announcement and speculators are placing bets.
- Hedging Purposes. How does it look technically? If you have a stock that looks like it could be in for some hard selling, you might see a lot of Put buyers coming into the market to hedge the downside risk. For the major indexes, this is usually the case when you see huge volume 20-30% from the current market price. Option buyers at these levels don’t really expect the market to fall that much but they need to have some “insurance” in case it does.
- Idiots Got Loose In The Market. I mean this honestly! The options market is full of a lot of beginning traders. Usually they will start out buying a lot of OTM options because they are cheap. There’s really no reasoning behind their trade nor any real analysis of the stock working in their favor. So they just make the trades and end up losing all their money extremely fast.
Now that you know what can cause the high volume, you need to know what it looks like on the pricing screen. High option volume is when there is stand out volume that is head and shoulders above the volume for similar strike options. Typically it can be 200% or higher volume.
Here is just one example of high option volume on the SPX Puts. Today there was 1,250 contract bought at a 500 Strike for January options and virtually no other options traded near it all day long. With the current SPX price north of 1,200 this is more than 50% below the market. CLEARLY, this is a classic example of hedging buy a large institutional trader and/or hedge fund. They want to protect their portfolio in case the market falls 10-20% or more by the end of January.
To effectively profit from high options volume you need to first identify the source: hedging, speculation, or idiots trading. Once you find out who is buying these options then only can you decide how YOU would like to make money off THEM. We have found that the most consistent strategy is to SELL the options that are far out of the money and keep the premium as they expire worthless. I guess you could consider us a stock insurance company making small gains month after month.