When it comes to learning new terms or strategies in options trading, you may feel tempted to learn everything. However, there is some information out there that could end up causing more harm than good.
In order to teach his students how to avoid distractions, and win up to 98% of their trades, David Jaffee has put together one of the internet’s best options trading courses.
Whether or not you’re new to options trading, you’ve probably heard the term unusual options activity.
This term is usually described to explain an option transaction that is abnormal in size (number of contracts) and / or overall trading volume.
Here are some scenarios that can be considered unusual option trades. Continue reading to find out how to approach these situations!
What is Unusual Options Activity?
Unusual activity typically refers to a substantial increase in trading volume, and is sometimes (but not always) accompanied by a large move in the underlying stock.
You can compare the current daily volume against the average daily volume for the underlying,
and if it’s abnormal (usually with an increase in contracts or volume) relative to the normal trading pattern, it could be something you want to keep an eye on.
Why would you want to pay attention to unusual activity?
Prior to taking action, you have to understand why there’s unusual activity in the first place.
It’s essential to keep in mind that, sometimes, unusual options activity can be due to a large hedge taking place, rather than traders expressing a directional view.
Part of a complex options spread trade
A speculative directional bet by a big trader
In general, David Jaffee from BestStockStrategy.com does not use unusual options activity when trading.
When asked about it, he considers it “noise” and a “distraction”. David Jaffee believes that it’s best to keep things as simple as possible, and he believes that unusual option activity is unreliable at best, and can actually hurt traders who rely upon it because many traders will misattribute causative properties to an indicator that may not be statistically valid.
Not sure what kind of options activity deserves your attention? Discover more information on options trading strategies that can help you be consistently profitable with David Jaffee’s options trading course.
Trading Options during a Downward Trend
In the case where there is a large volume of puts being purchased, and the price of the stock is following the direction of the trend, the market is probably betting on the downside.
What does this mean if you decide to be a contrarian and sell put options during this downward trend?
Selling put options during a downward trend is a good strategy if you don’t mind pocketing the premium from options or owning the stock at a price that is attractive to you.
In fact, because there are usually large volatility spikes during market corrections, the amount of premium that you’ll receive when selling puts into downtrends is usually very high.
For example, let’s say that a stock is trading at $30 / share, and you wouldn’t mind owning it at $15 / share. You can agree to buy the stock at $15 by selling a put option and collecting $2 / share of option premium.
As long as the price doesn’t trade below $15 at expiry, you get to keep the premium of $200 / contract.
As you can see, selling put options can be a win-win scenario if you sell premium on stocks that you wouldn’t mind owning at the strike price.
Overall, David Jaffee tries not to sell puts into major market corrections. During periods like March 2020, the market has a tendency to overreact and some stocks can lose 50% of their value in a few weeks. As a result, during major selloffs, it’s usually best to be patient and not enter the market until things have stabilized.
However, during normal pullbacks of less than 5%, and when volatility expansion is relatively normal, then David Jaffee believes it’s worthwhile to sell options during these times.
Do you want to learn when is the right time to place trades so that you can make money trading options? Read about how David Jaffee’s options trading course has taught over 1,500+ students to trade profitably.
Trading Options During an Upward Trend
When there is an upwards trend of a stock’s price and a high volume of call purchases, is it a wise decision to “fade the move” and act as a contrarian to the unusual options trading activity?
For options traders, It may feel like a good time to sell covered call options in order to pocket a substantial amount of option premium.
This is an attractive strategy for traders that already own shares in the underlying security, and want to collect the premium from the call options and make additional profit, while also participating in the upside potential of the underlying stock.
Let’s take a look at why this is the case.
If the price of the stock is trading at $30, and the strike price of the option is $45, you will realize an incremental $15 / share in profit on the long stock (not including the premium collected from selling the covered call) if the option is exercised prior to expiration.
If the stock price doesn’t breach the strike price before expiration, then the seller of the option will simply keep the call option premium.
While trading options, it’s best to stick to high-probability trades, mitigate risk, and focus on only the most important factors.
Too many indicators, or things to consider, can hamper your returns while trading.
This means that it’s probably best to not spend time monitoring unusual options activity.
In general, David Jaffee from BestStockStrategy perceives it to be a distraction that can do more harm than good.