Unusual options activity

Reading a burst of option trading in one name as a signal about where the underlying is going. The term predates the screeners that sell it: information-in-option-volume opens by citing the Wall Street Journal of 25 July 2002 reporting that the chicago-board-options-exchange was investigating "unusual trading activity" in Wyeth options, days before a government study on the company's hormone-replacement drug became public. That is the whole thesis in one anecdote — someone knew, and the option market showed it first.

The academic version of the signal is a put-call ratio built from option volume, and the research that establishes it also establishes most of the reasons the retail version underperforms it.

What the evidence supports

From information-in-option-volume (CBOE equity options, 1990–2001):

• The direction claim is real. A put-call ratio built from volume bought to open new positions predicts the next day's risk-adjusted return with a slope of −53bp (t = −32.92); the extreme quintiles differ by over 40bp the next day and over 1% the next week, decaying over several weeks.
• The contract filters a screener uses are the right ones. Predictability is strongest in options more than 10% out of the money and in options expiring within 30 days; it weakens with maturity and reverses sign for deep in-the-money contracts. Leverage is the reason, and it holds after comparing moneyness buckets of similar liquidity.
• Who trades matters. Signal concentrates in customers of full-service brokers and in stocks with a high concentration of informed traders; firm proprietary desks carry no signal at all.
• Single names only. The same test on SPX, OEX and NDX volume yields no evidence of informed trading, consistent with informed traders knowing things about companies rather than about markets.

What the evidence does not support

The predictive volume is not publicly observable, and this is the finding that separates the paper from the product. The CBOE dataset flags whether each trade opened or closed a position and which class of investor initiated it. Reconstruct the signal the way an outsider must — inferring buyer-initiated volume from the public tape — and it predicts for a day or two and then reverses, which reads as price pressure rather than information; run both signals together and the public one has no predictive power left. Open-buy volume carries the information, open-sell much less, close-buy none. A tape that cannot tell opening from closing cannot separate them.

So the retail screener is filtering the right contracts on a feed missing the field that made the academic result work. Nothing in this corpus measures how much of the effect survives that substitution, and nobody here has tested the retail signal net of costs.

The second reading of the same flow

Unusual activity is also a position, not only a bet, and that is where options-greeks enters. The dealer on the other side of an aggressive out-of-the-money short-dated call buy is short those calls, holds negative gamma, and must buy stock as the stock rises to stay hedged (dealer-gamma-exposure). pervasive-impact-of-option-trading measures that channel and finds it accounts for roughly 12% of an optioned stock's daily absolute return, with volatility rising or falling according to the sign of hedgers' net gamma.

The two readings collide on exactly the contracts a screener flags. The most informative contract in information-in-option-volume — far out of the money, near expiry, bought to open — is also the contract that hands the dealer the most gamma per dollar. So a stock moving after unusual call buying is consistent with the buyer knowing something and with nobody knowing anything and the hedge doing the work, and the flow alone does not distinguish them. Combining Greeks with unusual activity is not two confirmations of one signal; it is one observation with two mechanisms attached, and the practical question is which one you are trading.

Related

options-greeks · dealer-gamma-exposure · information-in-option-volume · pervasive-impact-of-option-trading · gamma-fragility · option-pricing · staskh-trading-skills · market-making · synthesis