Bullish or Bearish Options Trades? Some Clues to Figure it Out

An options trader once told me: "If I stopped to think about whether a customer's order represented a bullish or bearish call, I'd probably lose my job."

That doesn't bode well for figuring out whether a big trade in options represents an investor going long or short. Often, investors react to large volume numbers and think there is something afoot. But many times, it's more akin to a dog trying to sniff its reflection in the mirror.

Why? Because a big trade on the screen is only half the story. We know the size, strike price and expiration, but typically can't determine the identity of the buyer or seller, the level of confidence on either side, whether it was a trade between brokers on the floor, or if it was done against a stock position.

After all, if an investor went long on Dell (DELL - Cramer's Take - Stockpickr) by opening a 20,000-contract call position, wasn't there someone just as willing to take the opposite side of that bet? Well, sure, but the other side of that trade probably changed the price four times to accommodate the risk of being short 20,000 Dell calls and likely bought stock at the same time.

In short, it's tough to deduce investor sentiment from big options trades. For next week, keep sending your questions to the Options Forum and be sure to include your full name. For today, here goes:

In- and Out-of-the-Money Clues

I have two questions to ask you on the options front. First, there appeared to be a lot of calls coming in at the out-of-the-money strike prices for Silicon Graphics (SGI - Cramer's Take - Stockpickr). Is this a bullish indicator?

On the put side, there appears to be very little happening. Are investors gearing up for some good news, or is it just someone selling calls, expecting Silicon Graphics to tank?

My second question concerns Dell (DELL - Cramer's Take - Stockpickr). Someone placed an order to open 21,000 call contracts on the 2000 Jan. 15 calls with nothing on the put side. Is this a super bearish indicator? Or is it a really bullish indicator, buying calls so far in the money?

-- C. Addison

C.,

We consulted Brent Houston, managing director at Mr. Stock, a discount firm and options dealer. The simple answer is this: "There's often too little information to make a conclusion." Gee, thanks Brent.

Definitions first: An out-of-the-money call option has a strike price higher than the current price of the underlying shares. For example, Silicon Graphics on Friday was trading at 12 13/16. A June 15 call is out of the money, while a June 10 is in the money.

Back to Silicon Graphics. "Put-call measures tend to work on the theory that the public is wrong, and it's a contrarian indicator," Houston says. "Out-of-the-money call buying in Silicon Graphics might even seem bearish, that is, a sign of over-exuberance on the part of someone with unreasonable expectations, particularly when combined with a lack of put-buying."

Of course, that's not always the case. But the person who bought the calls is optimistic. The larger question is: Who's right?

"Traditionally, out-of-the-money call buyers have not been right most of the time," Houston points out.

To make things even more confusing, the question assumes that someone bought those out-of-the-money calls, but as Houston points out, "we just don't know that." Bumping up against that mirror yet?

"Maybe the trade is a sale," he says. "That huge call trade could be nothing more than a large holder of the stock deciding, 'Hey, the share price is going to stay flat, let's go in to sell those calls,' and the trading floor bought them. Maybe the holder thought they were worthless and dumped them."

"The safe presumption is that an investor and the floor made the trade. But did the floor buy or sell? That's why you need to know, and that's often difficult to find out," he adds.

The key to determining the true level of speculation in an out-of-the-money call play is the amount of the price increase. First, the higher the increase, the stronger the desire of the buyer to get ahold of the contract. Second, if the volume surpasses open interest, it's not someone closing out a position.

As for your second question:

You can't discount the obvious fact that this is someone buying deep (way deep) in-the-money calls as a stock substitute. But be aware of the other possibilities, as outlined by Houston:

"If you buy calls and sell puts, you're essentially going long the stock. Conversely, if you sell calls and buy puts, you're short the stock. If you pair them differently, you get different positions as well. It's hard to look at isolated trades like that and say this is what this participant is doing. You don't know what else they have.

"For all you know, the other position in that person's portfolio is that he or she is short half a million Dell shares." So even if they're buying those calls -- on our side of the mirror, a long call on Dell -- it could just be a hedge against a short position.

Market Muddle

I recently traded an option to sell at the bid. I got no fill whatsoever on a 20-contract order. My brokerage firm told me that in thinly-traded options the market maker is not obligated to buy or sell any options on the bid or ask. I thought they would be obligated to buy one or 10 of them. What is the rule? And does it vary by exchange?

-- Rich Klener

Rich,

Dave Gray with the Chicago Board Options Exchange tackled this one, and he says the broker may not be playing straight.

Once again, the CBOE has an investor services department you can call at 1-800-OPTIONS line and ask for Investor Services regarding problems or questions about execution.

Perhaps the market was moving too quickly. Getting an order filled depends a bit on whether it was a market order -- at the current market price, or a limit order, at a specified price.

A market order of 10 option contracts has to be filled pretty much immediately on the CBOE's network, according to this "10-up" rule.

(And the rules vary according to the exchange. For this example, we'll rely on the CBOE, which uses the RAES, or Retail Automated Execution System, network).

A limit order can also trade on RAES also if it meets the current bid-ask. That's what's known as a "marketable" limit order, i.e. one where your desired price happens to coincide with that of the market. For instance, if your limit order for options at 3/4 ($75 per contract) coincides with the current bid-ask of 1/2 to 3/4, it should be filled. If, between the time you send your broker the order, the bid-ask changes to 5/8 to 7/8, that's no longer a marketable limit order.

Sometimes, though, markets are racing. Under "normal market conditions, all series are good for 10 contracts," the CBOE's Gray says. In "fast market" trading, the 10-up rule can be waived because the trading is taking place so quickly that the system can't satisfy trades in an orderly manner.

CBOE's system actually has an overflow mechanism above 10 contracts, and handles up to 20 options contracts on its RAES network if the equity option is worth $10 ($1,000 per contract) or less; $40 ($4,000 per contract) or less if an index option.

"If the option is thinly-traded, it shouldn't make a difference. They shouldn't meet with any more or less market friction than anyone else," Gray said. "Candidly, it also depends on what type of firm you're using. Some smaller firms use middlemen on the floor for them."

Put-Call Postings

I've been following the CBOE put/call ratio on an end-of-day basis for some time. Is it available on the Internet on an intraday basis?

-- John R. Thomason

John,

First off, always give a ring to 1-800-OPTIONS (800-678-4667). That's the CBOE's help line, always worth a call to get the answer yourself. But, hey, that's our job, right?

Briefly, the answer is no.

"The sentiment is not going to change that much between the previous day's close," said a CBOE spokesman. "It should be more of a big-picture, broadbrush indicator."

There are other put-call ratios worth checking out. Compare the CBOE equity put/call ratio against the Pacific Exchange's equity put/call ratio, which the Pacific is plugging as a technology proxy since it's hinged to the options of Microsoft (MSFT - Cramer's Take - Stockpickr), Compaq (CPQ - Cramer's Take - Stockpickr) and Sun Microsystems (SUNW - Cramer's Take - Stockpickr), which trade only on the PCX.

You can pull up the Pacific's put/call ratio each day on the exchange's Web site (http://www.pacificex.com) under Options.

Splitting Symbols

It appears the Citigroup (C - Cramer's Take - Stockpickr) 40 put for July 1999 is being reported under two different styles. These are CSH and CIWSH. Different bid and ask prices are shown for each. How is it possible that this is permitted?

-- B. Milton Choate

Milton,

We too were wondering about Citigroup. It turns out a 3-for-2 stock split is the reason. This is what's known as an "adjusted" options series, because the underlying stock has been split, and the option contract has to be adjusted accordingly.

Eric Bielefeld, with options firm Hilliard Lyons in Louisville, Ky., had this very question from a customer recently. "The answer is pretty simple," he says. Well, we'll see.

First, the CBOE was on the case as of May 26, having issued a bulletin addressing this issue. You can find the bulletin on its Web site under the Trader's Tools section.

Then look under Stock Splits & Mergers, and type in the stock symbol or the options series symbol (in this case, CSH or CIWSH), and -- shazamm! -- there's the answer.

Citigroup announced a 3-for-2 stock split, with a payable date of May 28, to shareholders of record May 3. The existing options series were adjusted to reflect this 3-for-2 stock split on June 1.

"Normally, options represent 100 shares, but with the 3-for-2 split, the 100 Citigroup shares underlying the option have to be split-adjusted to make the options contract worth 150 shares," Bielefeld explains. Ultimately, as with most investments, the onus is on the investor to be aware of the additional shares under this option.