February 16, 2021
Options flow has gained great traction over the last few years. With a booming retail trading market, more people are trying to leverage options flow to gauge market sentiment and get ahead of others. In this post, we are going to talk about some tips on how to effectively use live options flow to find excellent trading setups. Since millions of options are traded every day, finding solid setups can sometimes be like finding a needle in a haystack. Therefore, one needs to understand different technicalities of options flow to separate the wheat from the chaff. This post will assume that you already know what calls and puts are. If you do no, please refer to this tutorial before continuing with this post.
Before we dive into the tips and tricks of using options flow data, we need to first talk about three different kinds of options orders that you will often see - Sweeps, Splits, and Blocks.
Sweeps are orders that are split up into smaller trades and are completed via multiple exchanges. There are many reasons traders often trade via sweep orders. First, if someone has some extra information about a company and they are confident that the price will move in a particular direction, they will want to hide their knowledge by using a sweep order. Since sweep orders are filled as multiple small orders, most people are not able to see the underlying large activity. Second, if a trader wants to get their order filled as soon as possible, they can often choose a sweep order to leverage the liquidity from multiple exchanges. In essence, a trader either wants to hide something or is in a hurry to complete a trader. Because of this fact, sweeps often provide us a signal that someone knows something that we do not which is why they are trying to hide their trade or get it filled as soon as possible. The image above illustrates the effectiveness of sweep orders. On February 16, 2021, we had two sweep calls early in the morning for $FUTU. The price of $FUTU was about 170 but one of the sweeps was for a $200 strike which is a very far out of the money strike. That tells us that someone is confident that the price of FUTU is going to increase shortly. How do we know if the price is expected to increase shortly? We look at the expiration date of the contract and see that there are only 3 days left till the contract expires. After that sweep, the price of FUTU did increase by about 20 dollars in the next few hours. The same contract that was being traded for $6.47 was trading for $14.07 in a few hours. This means the person in the second row would have garnered about 100% profits in a couple of hours. This demonstrates the power of sweep orders and how they can be used to find flow that we can follow as well to make money.
Similar to sweeps, splits are large orders broken up into small orders that are filled on a single exchange. The only difference between sweeps and splits is that splits are filled on a single exchange. The above example shows you a few splits for $CCIV on February 16, 2021. The first split came in when CCIV's price was only at $41 and the strike price for that was $50 which is very far out of the money. Low and behold, price went up to about 48 in the next few hours, and we had another few splits. Finally, the day ended with CCIV's price being at about $52 dollars. That is an increase of about 10 dollars in just a couple of hours.
Finally, blocks are just very large single trades. Usually, its large institutions buying or selling a very large number of options contracts. Those are considered as blocks in Tradytics live options flow tool. More specifically, any trade with at least 5000 volume is considered a block trade. Here is another example that shows you the power of block trades. Early in the morning on February 16, 2020, we received a block trade worth 1.32 million and 8488 volume for $AMTX. In just a few hours, the price went from 8.5 to 9.25.
Now that we know what each order type means, we can discuss some concise tips on how to effectively find good setups using options flow. These tips are quite subjective and come from our own experience in using live options flow to find trades. There are always more ways to look at the flow since it is more of an art than a science. However, we hope these will prove useful to you in your journey of becoming a better trader.
Bursts of sweeps, splits, and block trades with large premiums are often very useful. That can sometimes mean an event is about to happen and the people who know about it are promptly getting in before the price makes a big move.
Sweeps, splits, or blocks, when traded above the ask price often provide strong signals. That means a trader is willing to pay more than the ask price for the contracts. This shows confidence..
Similar to how a trade above ask provides confidence, trades with very short expiration dates also show urgency and confidence since traders are confident that the price will move in the desired direction very soon.
Very often, it is hard to identify whether a trade in the options flow is a buy/sell or part of a complex strategy like spreads, strangles, etc. In Tradytics live options flow tool, we provide you data on whether a trade was part of a strategy or a simple buy/sell. For newbies, it is often better to skip all trades that are parts of strategies as it is slightly harder to infer directional signals from them.
Whenever you see a large amount being spent on very far out of the money strikes, be on alert. Sometimes, if investors are confident in a large move, they will buy far out of the money strikes which are cheaper than in the money and at the money strikes..
When volume or a trade is higher than the open interest for the options contract, that can also sometimes depict urgency and confidence. That happens because smaller open interest demonstrates lack of liquidity. If an investor is still willing to trade the contract, that means they are confident..
This is a slightly hard point to understand but whenever IV increases significantly, it is often better to not buy contracts for the underlying stock. This happens because of a phenomena in financial markets called Mean Reversion. It states that certain things eventually revert to their mean. For instance, if IV gets too high, it is expected that it will eventually return to its average value soon. If you buy a contract at a very high IV, the decrease in IV will reduce your contract value thus causing you a loss..
Often times, before a big event like earnings, IV goes up quite a bit. As discussed in the above point, it is a good practice to stay away when this is the case. What usually happens is that IV suddenly decreased after the event causing the contract prices to drop with them. This is called an IV crush.
These are just some of our tips to keep in mind in order to find good trading setups and improve your trading PNL. You are welcome to try out our live options flow tool that has a wide variety of features with detailed manual filtering, your own watchlists, and plenty of ready-made filters. Our goal is to make life easy for retail traders and give them an edge. This tool will allow you to find your edge and complete with the big guys at wallstreet.
Finally, we would like to reiterate that analyzing options flow is more of an art than a science. Please spend time looking at historical patterns and build your own strategies. Options flow contains a rich amount of data that if used correctly can immensely improve your trading. If you like this article, do not forget to check our AI driven toolkit. We use AI algorithms on top of options flow and stocks data to give you an edge in your trading.