MorningWord 5/6/15: And prate about an Elephant, not one of them has seen.

by Dan May 6, 2015 9:32 am • Commentary

Regular readers know RiskReversal is not a trade service. We do not offer advice and we certainly don’t promise to reveal the secrets to riches. I am sure there are some people you follow on the web and tv that help make you money in the markets, and we hope we’re part of that by demonstrating the use options. But let’s be honest, only you, or your financial adviser are ultimately responsible for your investment returns.

There are some out there who believe that chasing unusual options activity can be a profitable trading strategy, that you are riding the coattails of the “smart money”.  It’s possible that that works over time if you do it relentlessly and structure your trades in a way that alleviates risk of being net long premium. But most don’t as most of the unusual activity that catches the imagination are out of the money lotto tickets done is size (although not the one I am going to detail below). And as often the case, especially on a one off basis, the trade you are chasing isn’t what it seems. Over the years we have offered no shortage of reasons why that is.  Here is the latest.  Yesterday Bob Lang cc’ed me on this Tweet:

This trade got some attention from those who like to follow unusual options activity.   Here were some of the other Tweets about this trade in ALTR, using terms such as colossal, huge, opening & bet:


But the reality of the trade was likely very different from what they were touting. There was a buy of 25,000 of the June 43 calls for 5.5o (to open) when the stock was $44.81 ($13,750,000 in premium).  But this is the report that I received from my broker on the Philadelphia Options Exchange:

ALTR jun 43 calls 25k trade 5.50 acct swap.

Given the take-over rumors of Intel for Altera, this sort of trade in size and the fact that it was in the money would show a good level of conviction that the stock would move above $48.50 in less than 6 weeks on June expiration.  But my takeaway was very different as I was focused the abbreviation “acct swap”.  This usually means that the trade was moved from one legal entity at a large financial institution (like a bank) to a different legal entity within the same institution, usually from an over the counter position that had not previously been reported to a listed exchange that is now being reported.  So could it still represent an outright bullish view, of course, but who knows when it was put on, how it is hedged, or what other positioning in the listed or otc market it is against.  You get the point.  You may ask how can I be so sure that this trade was not a very bullish trade, well I can’t.  But I once worked within a derivatives group within a large financial institution and often saw this sort of account swap activity internally and always marveled at the sort of questions we would get about this trade activity from the outside.

It’s possible that you could make money over time if you followed every unusual options print that caught your attention. Theoretically, all you’d need is for 51% of them to be what you thought they were. But that’s not how it works in the real world for part time traders. They have biases. They see a print in a stock they already like or hate and that print acts to confirm what they already thought. They also ignore prints that contradict what they already thought. And to compound the problem, they usually chase the trade with out of the money long premium, which definitely will lose you money over time.

So as usual we remain very skeptical of those selling the idea that trading off of all unusual activity is some secret within the options market. There is more to decipher and learn than what meets the eye.