Aug 09 2008

Tracking the Elephants

Published by Blaine561 at 12:00 am under Options Trading, stock market

Remember the joke: “How do you know when an elephant has been in your fridge? Answer: By the footprints in the Jell-O.”
 
Well, how do you know when the elephants are interested in a company? Answer: by the footprints in the stock option contracts activity. When the “smart money” (elephants) smells something happening in a company, they will normally position themselves to take advantage of the play by buying stock options-either calls or puts. Some option traders like to keep it simple and have formed a strategy by “following the money”. The underlying philosophy is that smart money is usually in possession of privileged information and that regardless of what the current technicals and fundamentals might show, a notable increase in option contract volume trumps the generally accepted picture and is a harbinger of some impending action in the price. But even though this strategy sounds simple, it is a bit more complex in that to determine whether or not real option contract volume has really increased or decreased.
 
Trading volume is a relative thing and needs to be compared to the average daily volume of the stock in question. A large percentage change in price accompanied by larger than normal volume is a solid indication of market strength in the direction of the change. On the other hand, a large percentage increases in a stock price accompanied by small trading volume is less likely to indicate a market direction. In fact, this scenario may indicate that a reversal is possible.
 
Open Interest
Open interest is a concept all option traders need to understand. As a matter of fact, most option traders ignore open interest. You see, unlike stocks, where there is a fixed number of shares to be traded, option trading normally involves the creation of a new option contract whenever a trade is placed. The Open Interest category depicted in the financial pages will tell an option trader the total number of option contracts that are currently open - in other words, “contracts that have been traded but not yet liquidated by either an offsetting trade or an exercise or assignment.” Therefore, when looking at the total open interest of a particular option, there is no way of really knowing whether the options were bought or sold. So what good is this information, you might ask? Be assured that the open interest figure does provide important information when understood.

One way to use the information provided in the open interest figure is to look at it relative to the volume of contracts traded figure. When the volume of contracts exceeds the existing open interest on a given day, this usually suggests that trading in that option was high that day. In other words, open interest in comparison to contract volume can help an option trader determine whether there is unusually high or low volume for any particular option

 
When stock options have large open interest, it means that the particular option has a large number of buyers and sellers and an active secondary market; this will increase the odds of getting option orders filled at good prices. In other words, the market for the option is liquid. As a result, the larger the open interest, the easier it will be to trade that option at a reasonable spread between the bid and ask.
 

Elephants do leave visible tracks but an option trader needs to know how to read those tracks. Being able to do so may be a simple and affective way to gauge where the next option trading opportunity might appear. It’s simple and leverages the power that privileged knowledge might have. As always, paper trade first before you follow the herd. Otherwise, you might get trampled or covered in you know what.

 

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5 Responses to “Tracking the Elephants”

  1. # » Tracking the Elephantson 09 Aug 2008 at 12:22 am

    [...] Online Social Classified Ads - OnlineAdsBlog.com wrote an interesting post today onHere’s a quick excerptRemember the joke: “How do you know when an elephant has been in your fridge? Answer: By the footprints in the Jell-O.” Well, how do you know when the elephants are interested in a company? Answer: by the footprints in the stock option contracts activity. When the “smart money” (elephants) smells something happening in a company, they will normally position themselves to take advantage of the play by buying stock options-either calls or puts. Some option traders like to keep it simple and have [...]

  2. # Tracking the Elephants · Stocks-Trading.ExplainedOnline.Neton 09 Aug 2008 at 12:42 am

    [...] Original post by Blaine561.com Screenwriter’s Blog! [...]

  3. # Tracking the Elephants · Trading-Stocks.ExplainedHere.Neton 09 Aug 2008 at 1:06 am

    [...] Original post by Blaine561.com Screenwriter’s Blog! [...]

  4. # Tracking the Elephants · Stocks101.ExplainedOnline.Neton 09 Aug 2008 at 1:17 am

    [...] Original post by Blaine561.com Screenwriter’s Blog! [...]

  5. # Tracking the Elephants · Stocks.ExplainedOnline.Neton 09 Aug 2008 at 1:18 am

    [...] Original post by Blaine561.com Screenwriter’s Blog! [...]

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