Suppose you are following a specific stock (XYZ) whose average daily option volume is 2,000 contracts. Then one morning you notice that the volume in the XYZ Jul 40 puts is more than 3,000 and that a single trade consisted of 2,500 contracts. Should that mean anything to you? Should you immediately take a position in XYZ because some valuable information has become available to you – based on the fact that all those puts traded? Can you assume that ‘someone knows something’ and this stock is about to undergo a severe price decline?
Opinions are mixed on this topic. Some will tell you that the high put volume is bearish and that it’s a good idea to buy some puts yourself, or perhaps sell the stock short. I disagree.
Bullish or bearish indicator?
First, you have no way of knowing whether the person who made the 2,500-lot trade was a buyer or seller, you don’t know whether that option trade was made by someone with a bullish or bearish bias.
But, suppose you knew whether the puts were sold by the market makers and thus, bought by some unknown investor. (Part of the time you can determine whether the market makers who trade with the customer bought or sold these puts by examining time and sales data.) But, does that really tell you anything? Again, some argue that if an investor (or hedge fund or institutional investor) buys a large number of puts (or calls), it cannot be an innocent trade. Surely someone must have some inside information about the company. I hope the discussion below convinces you that this is not a valid argument.
options are versatile investment tools and can be used in many different strategies,
you don’t know whether the put buyer is buying these options
as a bearish bet, or if the investor bought the puts to hedge an already
existing position. For example, a
stockholder may own 250,000 shares and have a very bullish outlook for the
stock. But, that investor may be willing
to buy puts as an insurance policy, just in case that the company issues less
than stellar news when it reports its quarterly earnings in a few weeks. This is an example in which the purchase of
puts was really a bullish play and not bearish. Thus, if you ‘follow’ that investor and buy puts yourself, you probably
have a bad investment because no one had any special information before buying those
may peak your interest when a large block of options trades, but unless you
know what the customer is doing, the information has little value for you.