By: Chris Rowe — November 16, 2021
Technical Tuesday - How "Unusual" Activity Leads to Unusually Big Gains
Insider trading happens all the time. How do I know?
I’ve worked on Wall Street for 25 years, that’s how.
Suffice it to say, there’s no way you can be as immersed as I am in the financial sector and never see head-scratching aberrations. When there is absolutely zero data supporting a surge in price, something is up with more than just the stock price.
Being on the inside doesn't necessarily mean that you are trading illegally, by the way.
Illegal insider trading is when executives end a company meeting where perhaps a merger was agreed to, or some new game-changing product was unveiled for the first time. Something like that.
And then, as soon as that meeting is over, they make a call to let some “friends” in on their little secret.
As for legal insider trading… Costas Bocelli tells a great story about an experience he had as a floor trader on the Philadelphia Stock Exchange. Click here to read it.
You don’t have to be a true insider anymore to get this invaluable information either. In other words, the aberrations I mentioned earlier are detectable.
We’re the good guys. We want to make money the right way. Which simply takes more effort.
But hey, that’s how good people get things done—the right way.
The research isn’t easy. There are a lot of steps. Let me give you a glimpse.
We need a place to start. To do that, we need a way to see aberrations. What kind of aberrations?
How about really big volume on a particular option of a stock that doesn’t usually see lots of volume?
How to Isolate Trading Volume Aberrations
Why would there be a sudden and surprising large volume on one particular option? (I’m not being rhetorical here—I’m really asking that question of you.)
I, literally, don’t know. And neither do you. That’s the point.
But it is a clue to let us know we need to do some more digging.
The following is not a trade suggestion. It’s just intended to give you an idea of how the information you need to isolate aberrations in option activity doesn’t require a position on the board of a company, or a political office, or a seat on an exchange.
Below, you can see Denbury Inc. (DEN), a United States based oil producer with a market capitalization of a little over $4.2 billion.
Now, the filter I used on my platform simply grabbed five companies that saw big option trading volume recently. I’ve highlighted DEN.
(Click any image to enlarge)
So far, this tells us very little. We need to continue our research.
What are we looking for? Well, if there’s suddenly a lot of option activity, I want to know exactly which option saw that increased trading volume. For all I know, it’s spread out amongst a lot of options.
So, I then look at time and sales. And lo and behold, there is very little volume on most of the options, with two exceptions—the January 2022 - 100 Strike and 120 Strike Call options.
It looks like someone just bought 3,000 January 100-120 Bull Call spreads at 10:16 am yesterday morning for 1.75 points ($175) per spread—a total of $525,000.
Okay, now I need some supporting data. So, I look at option prices and volume on DEN.
Not only do I find the purchase of the 3,000 January 100-120 Bull Call spreads on DEN, I also see a lot of activity on the November 90 and 95 Call options that expire this week. Also, a lot of volume on the December 90 Calls too—over 5,000 open interest.
Someone thinks DEN is going up. Take a look at the highlighted areas below. And look at the low volume in the unhighlighted rows.
So, now, let’s look at the chart on DEN.
And yep, not a ton of volume. You can see that highlighted in yellow on the left side of the chart below.
You can also see nice buying volume in the beginning and the end of October (highlighted in yellow), suggesting that there is institutional interest. And you can see the decreasing selling volume on the recent dip in price too, which indicates the move down doesn’t have much strength.
Otherwise, there really isn’t much standing out on this chart. Yeah, the Energy sector’s BPI chart is on a Buy Signal, and yes this stock has been on solid uptrend for the past year.
But there is nothing to indicate a surge in price in the next couple of months that would bring it close to $120 per share.
So, what other conclusion can I draw from such a large volume of the January 100 Calls, other than that some big investor out there knows something that I don't?
Again, I’m not at all suggesting there is a trade here. Right now, Energy is ranked #37 out of 45 on the Sector Relative Strength Matrix. This stock is also missing a number of other technical traits I look for.
But it’s a great example of how unusual option activity can clue us into what insiders are hearing. If I had looked at DEN’s chart and seen a lot of the technical traits of strength I look for, then the huge volume on the January 100 Calls would have clinched this trade for me.
But I’ve only touched the surface of what it takes to isolate unusual option activity and how to use it to make stock picks. I talked much more about how we can identify insider trading activity in the webinar Costas and I hosted yesterday.
Founder, CEO at True Market Insiders