Probably all people who trade stocks wish they had a crystal ball to see what the future will bring. While there are no guarantees of success, one way you can have a look into the future is to study patterns in option trading. Unusually large purchases of options contracts indicate that someone thinks there is an impending event that will move a stock in a big way.
Trading in the options market is a relatively inexpensive way to speculate about future stock price movements. If you think a stock is likely to rise in value, you buy a call -- the right to buy a stock at a specified price, called the strike price. If the stock rises in value, so will the value of the call. If you think a stock will drop in value, you buy a put -- the right to sell a stock at a specific price. When the stock price drops, the put rises in value. When a trader takes an unusually large position on a stock in the options market, it signifies that someone believes the underlying stock is going to make a dramatic move.
News That Moves Stocks
Stock prices do not usually make sudden changes without a reason. An FDA report on a pharmaceutical drug might move the stock price dramatically. Upgrades or downgrades by analysts can do the same, as can earnings reports that are out of line with analysts' expectations. The announcement of a corporate merger might make the stock price jump. An announcement of a new innovative product could do the same. If the news of such an event leaks before it is made pubic -- even if it is just a rumor -- investors will try to capitalize on the possibility. The most cost-effective way to do so is with options contracts.
Hedging and Insider Moves
Big investors, such as mutual funds, frequently hedge their positions through option trading. If a company has a large position in a stock it fears may be overbought, it might buy puts as insurance against a price correction. Another potential reason for unusually large positions in the options market is insider trading. It's illegal, but it happens.
Playing the Market
Sometimes a large block of contracts will leap off the screen of your computer, but it is more likely that you will need to use a screening source to find them. Large block trades are reported by Options Doggy (optionsdoggy.com). Other sites that report unusual activity are Options Insider (optionsinsider.com) and Options Monster (optionsmonster.com). If you can figure out the motive for placing a large contract, you too may play the position. Be careful and learn all you can before you trade. The options market can be volatile and you can lose money as quickly as you can make it.
Thomas Metcalf has worked as an economist, stockbroker and technology salesman. A writer since 1997, he has written a monthly column for "Life Association News," authored several books and contributed to national publications such as the History Channel's "HISTORY Magazine." Metcalf holds a master's degree in economics from Tufts University.