Questions to consider when looking at unusual option activity
There are many possible reasons why the original trader placed the trades that are being detected by our unusual option scanner. To help you with your due diligence before committing to this smart money there are a few questions you should ask yourself about the underlying:
- Is this trade a stock replacement ahead of earnings?
- Is there M&A talk surrounding the underlying?
- Could there be a government ruling (domestic or abroad) or new law that is coming out that would affect the industry the underlying is in or the stock itself?
- Is there talk that an activist investor will be taking a big stake in the underlying soon?
- Is there an investor's conference or analyst day surrounding the underlying?
- Are you noticing unusual option activity in the whole sector or just this stock (sector rotation)?
- If this is a drug company, have they planned for an FDA announcement that is coming up?
- Has there been a lot of positive or negative news said about the underlying from research firms, hedge fun or other influential establishments?
- Does this stock often correlate with the S&P 500?
Of course this is just a subset of the array of other reasons that a trader could have to place some of these unusual trades.
Another thing to keep in mind is to look at the notes section of the trade log. An option seller selling on the bid can have very different motivations vs a buyer of an option contract buying on the ask. All of this should also be considered in tandem to the length of the expiration.