Three minutes of fear

The Ultimate Guide to Unusual Options Activity Primer

The 3 Minutes of Fear with Unusual Options Activity

When your favorite Hedge Fund (“HF”) is buying options, they aren’t buying a 1 lot, or 100 lot for that matter. These funds have Billions of dollars of capital being put to work, which makes each position size much larger than ours. It’s what you see when you look at Unusual Options Activity trades.

That’s easy to understand.

It’s also easy to understand that HFs aren’t going to their favorite online brokerage account to make their trade.

Nope.

When the biggest HFs in the world want to trade options, they call up a top Investment Bank (“IB”) to place the trade. Within 3 minutes, that trade reaches an exchange and millions of investors get alerted or see it pop up on an Unusual Options Activity Scanner. 

Let’s better understand that 3 Minutes before you see the Unusual Options Activity.

Hedge Fund vs Investment Bank Relationship

The HF and the IB have a symbiotic relationship (usually). HFs need access to capital for leverage, and they need liquidity to execute their transactions. The IBs are there to help facilitate both for a fee through their Prime Brokerage divisions and their Trading Desks. 

On a daily basis, the IB’s Derivative (Options) Trading Desk is focused on executing large options trades from the biggest hedge funds in the world. This means they are prepared to commit their own capital to help the Hedge Fund make the trade.

Hedge Fund Trade Dilemma

For example, assume the HF wants to buy 5,000 XYZ Calls.

The market looks like this:

Bid Size            Bid Price          Ask Price         Ask Size

     28                  $1.00               $1.10                 43

If the HF went to the market on its own, then it’s highly likely that he would not get the $1.10 price shown for his size. There are only 43 contracts on the offer and the HF needs to buy 5,000.

The Role of the Investment Bank

The IB might show the HF a price of $1.10, or a “Stop” at $1.15.

This “Stop” means that the IB will go into the market and buy as much as he can from all the exchanges below $1.15. These are usually done with “intermarket" orders. Once the IB takes all the liquidity on behalf of the HF, then the IB will buy the remaining number of contracts at $1.15, and simultaneously sell them to the HF from the IB’s own account.

For example:
The HF bought 865 XYZ options from the exchanges for an average of $1.12.
The HF bought 4,135 XYZ options from the IB (it still trades on the exchange) at $1.15.

The 865 options traded as an “agency” transaction. The IB acted as the agent for the HF.
The 4,135 options contracts traded as a “principal” transaction. The IB used its own capital to provide “liquidity” to the HF.

Investment Bank Options Trader Dilemma

This trade execution might have taken no more than 3 minutes. It’s just one of many that occurs each day with all different customers at the IB.

Keep in mind, that the IB trader, who is taking responsibility for providing that liquidity to the HF, has a tough job handling a lot of risk. He is picking up the phone and speaking with a Hedge Fund that has fully analyzed the situation and the risk reward. The trader is then given less than 3 minutes to decide how aggressive he wants to be in facilitating the HF’s (the client) order. And remember, his mandate is to make the client happy (facilitate the trade) without losing the bank’s money!

The High Stakes

So, the less aggressive (i.e. worse pricing for the HF) he is, then the less likely the HF will be happy, and the less likely the HF will return to trade again. There are at least 10 IBs (Goldman Sachs, Bank of America, Morgan Stanley, JP Morgan, etc.) willing to play this game and fight for the multi-millions of dollars in commissions and fees that are at stake. It’s a very competitive game.

On the flip side, the aggressive (i.e. favorable pricing for the HF) IB trader is more likely to get repeat customers, win more customers, and earn more commissions. Unfortunately, it’s also more likely that the aggressive IB trader “gets caught,” or loses a lot of money on a particular trade (or many trades). Any one trade can cause significant losses in the millions of dollars.

So, those 3 minutes for the IB trader are akin to a gun pointed at the back of your head. It can be an exciting job; but, as you can imagine, not always fun.

My Experience on Both Sides

I played this game on both sides of the fence for many years, facilitating HF Option orders at Bank of America and then directing Option orders while sitting at a large HF. There are many nuances in this cat and mouse game that you learn over the years.

At the IB, the lessons that remain etched in your head are the ones that cost you the millions when you “got caught.” Never the ones that made you money.

At the HF, it was the answers to the “How” and “Why” that I found amazing. How did you come up with that idea? How do you know it’s an options play? Why did you choose that option?

This is What I See

When you look at Unusual Options Activity, you see the facts. “This option” traded “this many” times at “that” price.I look at those facts and envision the process.

I walk myself through the small details of how that trade likely went down. And not just the 3 minutes of fear faced by the IB trader. I also rely on my experience at the HF and walk through the process of how that idea was formed. Sometimes that HF process was 30 seconds and sometimes it was 2 weeks in the making.

So, focusing on those 3 minutes is just the start of your analysis.

Finding great options trade ideas amidst the daily Unusual Options Activity involves digging through data and analyzing it. This gets you down to a handful of trades.

The last bit takes some experience.

I created The Ultimate Guide to Unusual Options Activity to give you that experience. It reveals new information that helps you gain confidence in your approach.

Here's a clip of The Ultimate Guide to Unusual Options Activity.


The Ultimate Guide to Unusual Options Activity

Introduction 

Some of the smartest investors in the world manage the biggest Hedge Funds on Wall Street. Many of these Hedge Fund managers have made extraordinary returns over the years, and in the process, they have lined their pockets with billions of dollars. I call them the “Sharks.”

Are all of their trades profitable?

No. But each trade goes through a process to understand its risk profile. On occasion, the Shark chooses to use options rather than the stock. Because of the amount of money that they manage, which can amount to billions of dollars, the size of their trades is generally significant and stands out. And it's these trades that are the basis for the widely used strategy called, "Unusual Options Activity."

This guide draws from the lessons you'll find in 3 Steps to Profit and teaches the important nuances of the strategy that ultimately produces long-term profits. With options, one wrong move can cost you a significant amount of money. The Ultimate Guide to Unusual Options Activity will minimize those wrong moves and maximize your confidence with the right approach.

There are so many aspects of this Guide that makes it unique, and it starts right at the beginning. Most guides start by immediately describing the strategy and then filling in some details. They generally lack the logic behind the details that make understanding the details valuable. Even worse, it's assumed that you understand the end goal - to find Great Options Trade Ideas, but it's never quite clear what that means. This guide starts by making sure you fully understand what you're looking for ... so you know it when you see it!

Without further ado, let's define a "Great Options Trade Idea."

Part 1: A Great Options Trade Idea

Experience Matters

Unusual Options Activity is an easy-to-comprehend Options Buying Strategy. The widespread availability of new tools and access to alert systems then make the strategy simple to apply. There are even thousands of anecdotal stories on the internet highlighting huge profits made from Unusual Options Activity, which has increased its popularity.

The allure of quick triple-digit profits combined with high leverage and a "simple" strategy invites many investors to immediately start trading Unusual Options Activity. Unfortunately, this causes them to overlook the details that ultimately make the strategy profitable over time.

Watch this quick preview to learn more about my unique experience and see exactly where I'll be able to help you. I want your full attention from the start.

After the video, it should be clear that there are many parts to Unusual Options Activity. Most "gurus" don't talk about the other parts because they lack the high-level experience needed to understand the nuances. While the strategy starts with finding the trades, long-term success needs a deeper understanding of the behind-the-scenes chain of events.

This starts with knowing how to define a Great Options Trade Idea.

Searching for Ideas

The goal of buying options is to find Great Options Trade Ideas. And while Unusual Options Activity can lead you to them, there are several ways to reach your goal. This diagram shows you a few of the most common areas where investors start their search:

Great Options Trade Idea
  • Options Analysis
  • Technical Analysis
  • Fundamental Analysis
  • Data Analysis
  • Quantitative Analysis
  • Use of a Product
  • Read an Interesting Article

Each of these entry points offers a valid start; however, keep in mind it usually takes multiple layers of analysis to reach your goal.

What is a “Great Options Trade Idea”

Many investors judge an Options Trade Idea by the profit or loss it delivers. For them, a huge profit means it was a “Great Options Trade Idea,” while a losing trade means it was a lousy Trade Idea.

Don’t look at options this way. It’s backwards thinking.

Investing successfully requires you to make the best decisions with today's available information, and then risk manage that decision over time. This next concept is the ONLY concept that will allow you to do just that...


Take the next step to learn a systematic process that teaches you how to use Unusual Options Activity to find actionable Trade Ideas. These Trade Ideas consistently generate returns of 100%, 200% or even more than 1,000%. 

The Ultimate Guide to Unusual Options Activity

Ultimate Guide to Unusual Options Activity Primer