How to Use the Concept of Unusual Options Activity to Spot Opportunities – Introduction
People have been doing commerce with one another for decades. The traditional commerce was rather basic because it involves buying and selling for consumption purposes. As the world became more advanced, the people needed other ways to do business. This led to the creation of companies that manufactured the things that people needed in scale. For example, companies that manufactured wheat flour were created. As the sophistication of the industry increased, it led to the discovery of new ways of doing things.
One such discovery was the options market. In options, the farmers were able to lock-in a future price of their commodities while the manufacturers were assured of a supply. This worked this way. Before a planting season, farmers would approach the manufacturers and negotiate a future price that the manufacturer will buy the goods. If they agree, the farmer will plant his crops and be sure to find a buyer. The price had to be agreed by the two sides.
During the harvest time, the farmer will take the harvest to the manufacturer who will buy as agreed. If the market price is low, the farmer will benefit because his goods will be bought at a higher price. If the market price is high, the farmer will be at a loss because he would have sold his produce at a higher price.
The same concept is now applied in the financial markets and is one of the most-closely watched method of trading. In fact, the VIX index, which is also known as the fear index has been developed using the concepts of the options market. The options it covers are those of the S&P 500.
There are four ways you can use the options concepts. First, you can buy a call option. This type of option gives you the right – but not an obligation – buy at a certain price. Second, you can buy the put options. A put gives you a right – but not an obligation – to sell at a certain price. This price is known as the strike price. Third, you can trade the risky binary options. In these, you forecast the direction in which the price of a security will go. If it moves in your direction, you make money and if it moves against you, you lose money.
Fourth, you can use the concept of options to search for abnormal activity in the market. This is more ideal among US stocks because this data is usually available. By checking the options market, you can easily see how insiders and large investors are pricing in the movements. For example, if the average volumes of options for a company like Twitter is 300, and then you find that the volume of a month’s options have increased to 3000, it means that an insider probably knows something that you don’t know. If these options are ‘put’ , it means that the trader expects the price of Twitter to move up. As such, you can buy Twitter and wait for the price to move up.
As a precaution, you need to first take time to learn more about options and how to spot the unusual activities. Second, you need to know that the concept does not always work out because no one knows how the market will react when the news breaks. Third, it is important for you to protect your trades with a stop loss.