Option flow is by far the hardest technical tool to understand, because most of it is meaningless. Here’s what signals to look for.
Today’s options trader is armed with dozens of tools to help you find an edge. Options flow is one of them. It’s unique in that it tells you where big institutions like banks and hedge funds are investing (or divesting) their money.
But there’s a caveat: Much of money flow is not actionable, just informative. If you want to use it to guide your trading, you need to be able to discern between the two.
Back when I started reading option flow, I was lost. I knew buying and selling large volumes of options had to mean something, but what? I’d see 1,000 calls sold on Microsoft, 5,200 puts bought on IBM, and 10,000 calls bought on the QQQ. It had to tell a story, right?
Well not necessarily. I quickly learned that sometimes the biggest trades lead nowhere. This still happens to me today even after years of analyzing flow.
The point of following option flow is to find the occasional outlier – the big trades that are meaningful. As it turns out, few are.
Only 30% of flow is meaningful, and of that number, only 70% is actionable. So, that leaves us with 20% that is worth paying attention to.
Here’s how I find that 20%:
I look for repeating trades.
Big institutions tend to work quietly, so multiple trades in one name can sneak in under the radar. A thousand here, a few thousand there, and pretty soon you have significant volume going into IBM.
Besides surges in volume, I watch the price action and crossover moves between calls and puts.
One tool I really like to help me find and understand option flow is Quant Data from my friend Andrew Hiesinger. Andrew is a trading veteran who worked at the NYSE and Nasdaq while creating it. He joined me for a recent options trading webinar on understanding option flow when he broke down the complexities of flow into very manageable parts. If you want to better understand option flow, definitely watch the webinar (it’s one of my all-time favorite webinars, and I’ve done hundreds of them).
