Under the right conditions, high options volume can tip you off to some potentially explosive moves in individual stocks. Of course this doesn’t always happen, but when you see high volume you need to know what to do next.
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 options volume is usually staring you in the face when you see it.
There are usually only 3 main reasons for high option volume
Upcoming News: Do you see any kind of hint or 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 option 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 abnormal volume that far exceeds the volume for similar strike options. Typically it can be 200% or higher volume.
Here is just one example of high call option volume. Today, there were 3,737 contract traded at the $110 strike price, more than five times the amount of other options traded. Could this be speculation or idiots loose in the market? Either way, volume is telling you something.
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 you can decide how 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.