The financial media likens unusual options activity to some sort of tell as to what the “Smart Money” is doing. In some ways, that is correct but in other ways it can be very misleading.
Most savvy traders will take the time to try to get a sense for the options flow in a stock they are involved in, to glean speculative sentiment in the stock. Gauging sentiment is probably the main reason we highlight unusual activity, or changes in open interest. Particularly in situations where a stock is in an extended position (either high or low), options activity can sometimes signal smart money starting to get contrarian (one large block going the other way), or dumb money getting euphoric (lots of small lot activity going the same way).
However, we have always been skeptical of reading too much into unusual options activity. There have been many times in our collective careers where we have traded or seen others trade calls or puts as an offsetting position against the actual directional trade. For example, one hedge fund manager back in the summer of 2008 would notoriously sell puts on some of the distressed financial stocks (like Washington Mutual), but would be shorting stock against those put sales one for one. He was taking advantage of the high implied volatility on the downside to collect some extra premium, but his put selling activity was actually the opposite of his actual directional position.
Alternatively, we’ve seen many situations where large traders have bought puts or sold calls against a new long position. One of my favorites was a trader who would buy up his stock position first, and then ask for an offer on puts in that stock. Since he was the one who drove up the stock in the first place, he got a better entry on the stock and long put combo than if he had traded both together.
The point here is that blindly following the “big” money simply because of large options trades can be a dangerous game in situations where the activity could be hedging against the traders larger position in the underlying. Options activity is worthwhile to follow as one piece of the trading puzzle, but only as one piece. Traders should be careful about those touting strategies that follow the big prints as a method in itself. The issue is compounded by a confirmation bias on the part of those touting large options activity as the only input in a new trade. You’re likely to hear about the ones that worked, and not a peep about the ones that didn’t.
So be careful on this strategy. Don’t blindly follow unusual activity in options without looking at other inputs. Because oftentimes, you won’t be following the smart money, but rather walking blindly into a stampede with the rest of the herd.