Should You Pay Attention To Options Order Flow?

PreMarket Prep’s Dennis Dick recently discussed outside options volume and whether or not it can be used as a trading indicator. The media often reports unusual options volume at deep out-of-the-money prices. Dick said lots of traders assume that type of volume comes when sophisticated traders know something about a company which may not yet be public.

“There is something to that,” Dick explained. “If there are insiders that have inside information, it’s a lot easier to put on an outside option position than to go out into the open market and buy stock.”

However, Dick said he believes most of that volume is simply hedging.

“The majority of the time, a lot of these big options purchases that you see occurring outside of the market are hedging tactics. They’re defensive plays where somebody’s got a big position on and they know they’ve got to buy some outside puts to protect their position,” according to Dick.

He recalled a time when one of his friend’s hedging trades was reported on CNBC, and the hosts speculated that a trader much have information on the stock.

“Sometimes people will read more into it than is really there. If you make money using outside options as indicators, by all means continue to do it. It’s something I do not incorporate in my own trading because it’s kind of like finding a needle in a haystack,” he concluded.

PreMarket Prep guest Tommy Lackey, managing partner and portfolio manager at Relativity Capital Advisors, sees things a bit differently.

He noted options activity can be the first sign of major institutional buying and selling if traders know what to look for.

“People always talk about the 13F filings. Guess what? A lot of those positions are bought in the options market months before. These days, it’s much easier for them to go and buy 5,000 in-the-money calls than it is to buy 500,000 or more shares without moving the price,” Lackey explained.

According to Lackey, it takes a bit more sophistication than simply looking for volume to get a feel for which options trades are likely hedges and which ones could potentially be indications of where a stock’s share price might be headed.