What Is Unusual Options Activity And What Does It Tell You?

Unusual options activity is one of the best ways to see how traders are betting on a particular stock or fund. Each day the exchanges report that day’s volume for each strike price, allowing everyone to see how many contracts changed hands. So traders may be able to deduce what other options traders think is an attractive set-up and how much they’re betting on it. 

Here’s what unusual options activity is – and why you want to be careful trading it. 

What is unusual options activity and what does it tell you?

Unusual options activity often occurs when one or a few traders make a large option transaction on a single day for a specific security. The volume is reported on each day’s options chain, allowing traders to see which specific strike prices saw unusual trading activity for that day. After that day’s trading, the number of existing contracts at each strike is reported as “open interest” on the security’s option chain, and that day’s unusual activity is not otherwise visible.

Generally, unusual options activity is characterized by massive spikes at one or two strike prices rather than high activity at a range of strike prices. This unusual activity indicates that a trader is putting on a trade at those high-volume strike prices and wants massive exposure to a certain setup of risk and reward. 

Many options trades take place “near the money,” that is, with strike prices close to the stock’s current price. So it may be more difficult to spot unusual activity on a given day if it occurs near the money. It can also be more difficult to see unusual activity in highly active options markets, such as for the most popular tech stocks or the Magnificent 7 stocks. Unusual activity may be more apparent when it’s farther away from the current stock price, either well in the money or well out of it, like a zebra caught away from the rest of its pack. 

Unusual options activity may indicate that a knowledgeable – or at least, well-financed – trader is putting on a significant options trade. This trader may have a specific investment thesis and is expressing it via options, which can be one of the fastest ways to make money, if you’re right. 

It can require a significant amount of money to create unusual options activity. For example, a trade of 10,000 call contracts might be considered unusual for a given strike price. If the contract costs $3 to buy, then it would cost the trader $3 * 10,000 contracts * 100 shares per contract, or a total of $3 million. That’s a huge amount of capital that could be lost if the trader is wrong.

Many traders use advanced trading strategies that have multiple “legs,” allowing them to adjust the risk and reward in ways that seem favorable. So when you spot unusual volume at one strike price, you may find it at one or more other strike prices if you poke around the options chain that day. This type of activity suggests that a trader is putting on an advanced, multi-leg strategy. 

Specialized research services and the best brokers for options trading may help you spot unusual trading activity and help you analyze what it means.

Trading unusual options activity and how it can be dangerous

The news that a well-financed trader or two have made some large option transactions may be a good signal that it’s something worth investigating. But copy-cat traders need to be careful if they intend to replicate the unusual options activity that they find. Here are a few things to consider:

1. You need an investment thesis

While unusual options activity may alert you to a potential opportunity, it doesn’t tell you what the trader is thinking by making the trade. You’ll need to come up with your own investment thesis for why the underlying stock offers a good opportunity and then determine your own option strategy. You may decide that a basic option strategy is a better way to make the trade. 

It’s the same process when you see a famous investor such as Warren Buffett make a stock investment: If you don’t understand why he’s investing, you shouldn’t make the trade. Famed investors could sell their position and be out of the trade, and you won’t understand why if you’re only making a copycat trade. So you’ll need to do your own work if you want to make the trade.

2. An option trade may mean the stock is attractive

Don’t assume that an option trade is your only play when you see unusual options activity. If you can figure out why the option trade is attractive, it may be a signal about how the stock could perform in the future. For example, if the implied volatility on a historically volatile stock is relatively low, it could indicate that the stock is an attractive purchase or is at an inflection point. 

As with the first point above, you’ll need to do your own work to understand the opportunity. 

3. It may be difficult to judge what’s going on

It may be hard to figure out what the unusual option activity is telling you. You can spot the activity easily enough, but is the big trader selling the puts or buying them? If the trader is setting up a multi-leg trade, you may end up concluding that their strategy is exactly the opposite of what it actually is. If so, your options exposure would be just the opposite of theirs, too. 

That said, traders do have some tools to help judge whether large trades were made at the bid or ask price, helping indicate whether the trade was someone selling or buying. A large sale of options may push down the price, while a large purchase may increase the price, relative to the theoretical price indicated by options pricing models. Some brokers and others may provide tools to help you decode the action. 

4. Every trade has a buyer and a seller

Options trading is a zero-sum game. Every call or put trade has a buyer and seller, and both think they’re making a good trade. Only one of them can be right. A big options trade doesn’t necessarily mean that “someone knows something.” 

Again, unusual options activity should indicate a place where you might want to do further research rather than make a kneejerk trade following an unknown trader.

Bottom line

Unusual options activity can offer an opportunity to view the workings of some of the market’s traders, perhaps allowing you to piece together how a smart trader is positioning a portfolio. But you’ll want to be careful if you’re trying to replicate the trade without doing your own work.