This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Options 'Flow' Foretold Questcor Plunge

Let's discuss interpreting these unusual trades. Unless you see the trades go through or have access to the size and pricing data (most retail traders don't), making sense of unusual option flow is more of an art than a science. I suggest you observe what is known and draw the most probable conclusions.

First, find what trades appear linked. With respect to small-cap biotech stocks, this is usually very obvious. For example, the figure below shows the option chain for typical small-cap biotech stock XYZ. The Bid/Ask spreads are wide, option volume and open interest is sporadic and unevenly dispersed. Note the unusual trades in the SEP 5.0 Puts and SEP 7.0 Calls where 3,000 volume just passed (unusual due to size relative to both volume and Open Interest or O.I.)

The first assumption is that these trades are linked. It's possible that two separate traders in two different locations put on these trades in exactly the same size and on the same date, but that's obviously unlikely. Next, look at how these trades were executed i.e. were they sold or were they purchased? (As each respective trade is larger than current O.I., we can assume they are opening positions.) In this situation, we know the "last" price of both trades. For the Calls, 3,000 were transacted at 95 cents and for the Puts, 3,000 were transacted at 80 cents.

Next, compare the prices transacted to the current bid/ask prices to get an indication of whether or not they were bought or sold to open. The Calls appear to be initiated on the buy side as 95 cents is closest to the ask of $1. The Puts, on the other hand, appear to have been initiated on the sell side, as 80 cents is the current bid quote.

An alternative approach would be to observe changes in implied volatility (IV) from the trades: Where an increase in IV would be indicative of buying activity and a decrease in IV would be indicative of selling activity.

The last step is to determine if the trade is bullish or bearish. Based on our analysis, the XYZ option trade appears to be a SEP 5.0 Put, SEP 7.0 Call Risk Reversal done for a 0.15 Debit 3,000x. This is a bullish trade.

Following unusual option activity helps manage risk in existing position and can also identify potential new trades. Monitoring flow is not foolproof but following "big money" trades can give retail traders a solid edge.

Disclosure: No positions in QCOR.

To learn more about using options to trade biotech stocks, check out Tony Pelz's book, The Biotech Trader Handbook or subscribe to Chimera Research Group

Tony Pelz was a trader on a major European bank's proprietary trading desk, responsible for a portfolio with limits of more than $200 million. Prior to proprietary trading, Pelz worked with several global investment banks in roles ranging from corporate finance, M&A to credit and business development. He is author of The Biotech Trader Handbook, 2nd Edition, co-founder of the small-cap biotech research and trading site Chimera Research Group and operator of PelzOptions.com. Pelz currently resides in Denver, Colorado where he trades for his own account.
2 of 2

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,960.57 -123.23 -0.72%
S&P 500 1,978.34 -9.64 -0.48%
NASDAQ 4,449.5640 -22.5440 -0.50%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs