Options 'Flow' Foretold Questcor Plunge

NEW YORK (TheStreet) -- Trading or investing in biotech stocks is often a high-risk venture. To manage some of this risk with your existing positions -- or to identify trade opportunities for new positions -- it often helps to follow what the so-called "big money" investors and traders are doing. This is often accomplished by looking at public filings of major investors or funds. I prefer an alternative approach: Monitoring unusual option activity or "flow" on a daily basis. Keeping a close eye on the option flow in real time gives me insight into what large traders and investors are doing and helps foreshadow future stock-price movement.

Questcor Pharmaceuticals (QCOR) is a perfect recent example of why monitoring option flow can be so important for traders. Last Tuesday, very large and unusual activity in the October Puts was spotted. It looked like a large trader, most likely a fund or large existing stockholder, purchased 8,000 of the OCT 50/40 strike Put spreads i.e. purchased to open ~8,000 OCT 50 strike Puts, and sold to open ~8,000 OCT 40 strike Puts while the shares were up $2 on the day. This was a very bearish trade and was unusual in size.

The next day, negative news broke about reimbursement coverage for Questcor's drug Acthar. The stock dropped over 50% on heavy volume. Irrespective of what the large trader knew beforehand about this news (coincidence?), the returns on the trade were stunning and the lesson to the smaller trader/investor was clear: Integrate option flow monitoring into your daily routine.

[Questcor shares fell 30% to $21 Monday following disclosure of a U.S. investigation into the company's Acthar drug marketing practices.]

Retail investors or traders can identify unusual option flow quite easily by paying attention to a stock's Options Chains or by the unusual trade alerts or monitoring services offered by most option brokerages sites.

Unusual volume for most small-cap biotech companies typically translates into volume greater than 1,000 contracts and several times larger than current Open Interest. (This needs to be put in perspective with average daily volume levels.) The trades to really focus on are those executed in large blocks, like the trades seen in Questcor last week.

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