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business newsHow to Read Options Activity
Four ways to help you know if a trade is a buy or a sell.
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Unlike a stock, in which there are a limited number of shares available to trade, the number of option contracts that can be created is unlimited. Unlike the underlying stock, in which a rise and fall in price can create or destroy value for all involved, options are a zero-sum game. That is, come expiration the option will have a specific value (potentially zero), and the amount of money made in a specific contract will equal the amount of money lost in that same contract.
In terms of deciphering any meaning from the action, that becomes a combination of art and science. The science or factual part of basic reporting on option transactions is fairly straightforward and easily accessible. These are the four main items you want to identify:
1. Volume or the number of contracts traded on any given day. This can be found anywhere including the Yahoo Finance page, any number of financial websites, almost whatever brokerage firm you use, and paid sites such as Bloomberg or subscription services such as TradeAlert. One of my favorite sites for breaking down option activity is What’sTrading.com.
2. Compare this volume to the prior open interest in the strike. If daily activity exceeds the prior open interest, it's safe to say the activity is the initiating of a new position. Again, to find the prior open interest, one can use the same resources. For example, on Monday more than 5,000 calls traded in Reliant Energy (RRI) in the August $4 strike. Prior open interest had been just 268, so it was safe to assume this was new positioning. Indeed this morning open interest is 5,900 contracts.
3. Determine if someone is buying or selling. Despite the fact that for every buyer there is a seller, you want to focus on which party initiated the trade. This is where art enters the equation, but it's good information that can provide a clear picture. The first step is to look at time and sales. Again, this can be found at the above sources, but I'd lean toward your broker, anyone from OptionXpress (OXPS), Ameritrade (AMTD), or Schwab (SCHW) makes this a standard part of its option chain information.Bloomberg and some other paid services ensure accuracy and timeliness. Time and sales data will show how many contracts traded at a specific price and a specific time. If the transactions were mostly executed at the offer price, it is safe to assume that most of the activity is being initiated by buyers. This will also make itself known by changes in implied volatility. If the initiating party is the seller, then the transactions will have been done at the bid, and there likely will be a decline in implied volatility.
4. This may seem obvious, but look at current or upcoming news events. Are their upcoming earnings? A court ruling? Is the stock confirming the option activity -- that is, is call buying being accompanied by a raise in the share price, or is this a hedge? It's possible it's something as simple as a covered call, in which what might seem heavy selling of calls or a bearish activity is really part of a bullish position.
That said, no one except the participating parties can know for sure what any given transaction represents or if it will prove to be a contrarian indicator or smart money establishing a fresh position.
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