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Aetna Options: Beware of Unusual Activity


Using anomalous moves to guide trading decisions may be a mistake.

Aetna Options Strike Out

Reporting on option trading is often like covering baseball: Home runs tend to be highlighted while the mundane, though much more frequent strike-outs that occur during a game, are typically ignored.

Similarly, unusual options activity -- suspicious or otherwise -- that precedes a major move can command the attention of market watchers. (This unusual activity could be a merger, or a news event, that results in windfall profits.)

But the reality is that the batting average for unusual option-activity reports being truly predictive (let alone, profitable) is very low.

A Fat Pitch

Yesterday's action in Aetna (AET) offered a prime example of why it's not always a good idea to use unusual option activity as a lead or trigger for a trading decision.

Even as the broad market was generally lower and the health-care sector was being dragged down by a warning from Cardinal Health, shares of Aetna held in positive territory above $30 throughout Tuesday. But what caught market-watchers' eyes and prompted signals from trading software was the fact that option volume was 5 times the daily average.

The bulk of the option activity was focused in calls - specifically, the July $30 calls, which traded 8,700 contracts. This was 4 times the strikes' prior open interest. Almost 85% of transactions occurred at the $1.05 asking price, suggesting this was new buying and that someone was accumulating calls.

There was no apparent news. But Aetna is slated to present at Citi Healthcare Services' conference today. Surely some smart player was anticipating positive news to emerge. Heavy call-buying ahead of conference? Hmm. Traders that used this type of data signal for initiating trades must have felt there was a big fat pitch they could get behind.

A Whiff

There was indeed news brewing. In fact, it was so important, it couldn't wait until today's conference. After yesterday's close, Aetna issued an earnings warning and lowered guidance. Shares dropped over $3 in the aftermarket and are poised to open sharply lower this morning.

The value of those calls will likely be cut in half. The people that piled into that trade just experienced one of the many strike-outs that happen in speculative option-buying everyday.

Some might point out that the calls only cost a buck, so it was worth the calculated risk. And that it only takes one big winner to more than make up for the losers.

But take a look at the players that populate Cooperstown; the measure of a hall-of-fame player is more often consistency over their career than a year or 2 of record-breaking performances. After all, there can only be one home-run leader. And it's turning out that many of the recent home-run kings -- in both investing and baseball -- were juicing their performance one way or another.

Not so Unusual

As discussed in my article, Reading Options Activity for Future Moves, the software and systems in place today are very sophisticated and can pick up on even the slightest deviations of option-trading patterns.

But this can be a double-edged sword. While the super-fine filtering and screening flags a large number of unusual trades, so many options are thinly traded that it only takes a small bump in volume to trigger an alert. The reality is, most won't prove to be predictive, or correlated to any impending price move.

The lesson, like always, is take all information in a larger context, understand risk/reward, and don't blindly follow anyone or anything; doing so could lead to a swing instead of a hit.
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No positions in stocks mentioned.

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