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VIDEOWhat Do Speculators Know About High Options Volume?, Part 2
The answer: Not very much.
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Two weeks ago, I used data on options expiring on February 20, 2009 to conclude that high volume in options trading provides a weak signal for speculating on the future price direction of the underlying stock.
Specifically, my analysis of options expiring February 20, 2009 produced 2 main observations:
1. The overall (downward) trend in the market dominates stocks' price performance regardless of the options trading. For example, stocks perform nearly the same (mostly negative) between the date of the high options volume and options expiration, whether the high options trading volume is only in calls or only in puts. Also, the maximum price gain in a stock improves slightly if just puts are traded in high-volume instead of just calls.
2. When both puts and calls are traded in high-volume on the same underlying stock, the stock's price performance is at least equal to the cases where only calls or only puts are traded in high-volume.
As a follow-up, I ran the same analysis using options expiring March 20, 2009. This next analysis produced similar observations as the last one. The environment for trading was slightly less bearish than the 7 weeks used in the first analysis. In the first analysis, the market trended downward almost the entire time. For this second analysis, the market trended down sharply for almost 5 weeks straight before bouncing sharply for the last 2 weeks. This sharp rally is likely responsible for the resulting stock-price action being less bearish than the first analysis. Here are the main observations from this second analysis:
1. As I found in the first analysis, stocks in aggregate perform nearly the same between the date of the high options volume and options expiration, whether the high options trading volume is only in calls or only in puts. The small performance gaps that exist were even smaller this time. The strong rally in the last 2 weeks of this data sample significantly increased the percentage of stocks with maximum gains over 10%, and it notably decreased the percentage of stocks with losses of at least 10%.
2. As I found in the first analysis, when both puts and calls are traded in high-volume on the same underlying stock, the stock's price performance is at least equal to the cases where only calls or only puts are traded in high-volume. However, this second analysis seems to provide even stronger evidence that this kind of trading is the most reliable signal for generating high returns.
It also still makes sense to close out these trading positions in advance of expiration once you achieve a "significant" move in your favor.
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