Unusual Options Activity

If you ever tune into CNBC's Fast Money show, you may have heard one of the Najarian brothers cite unusual options activity happening in a particular stock, but many of you out there may not be aware of the implications of this observation. Generally, when something big is about to happen that will significantly affect a company's stock price, many greedy insiders will buy options before the market-moving event is announced. Why don't they just buy the stock? For a couple of reasons. First of all, trading on inside information is illegal and buying stock is tantamount to signing a confession. Everyone knows who bought what and when they bought it. But it's a lot easier to cloak your identity in the options market where market activity isn't actively monitored. The other big plus is the increased leverage that options have over stocks. Why make a little money when you can make big money?

Insider trading is illegal and people who are caught face time in the hoosegow. Just ask Martha Stewart. The fact that it's illegal doesn't stop many people from doing it, and one way they tip their hand that something's up with the underlying company is by a significant increase in options volume as well as open interest. (Open interest is just the number of contracts that aren't yet closed out.) Although the Najarians tend to only look at volume, to me it makes more sense to look at the increase (or decrease) in open interest. A spike in volume doesn't necessarily mean a corresponding increase in open interest. Also, a change in an option's implied volatility might also be a telling factor.

Sudden changes in any of these options statistics can signal an explosive move in stock price due to one of the following major events:

1. Mergers and acquisitions
2. Substantially better (or worse) earnings will be reported
3. Analyst upgrade/downgrade
4. New product launch or product breakthrough
5. Clinical trial results or FDA approvals
6. Significant company news, such as CEO departure, SEC investigations, etc.

Why am I bringing this up? Because for years I've been jonesing to do some research on this subject, so basically I'm just making the announcement that I'll be doing as such over the next few weeks (or as long as it takes.). When I have some results, naturally I'll let you know. Even if you're not a member of the “smart money” set, you'll be able to profit right along with them, and do it legally, too. And isn't that a whole lot better?

I'm heading out to the beach to hang ten. (Hang ten for me means taking a brief snooze.) Have a lovely weekend!