The options markets gave a great heads-up that a deal was brewing for First Data ( FDC), and I noted that last Wednesday there had been a surge in call activity and suggested that options activity was speculative and that it indicated a buyout bid that would have a 25% price premium.Jim Cramer picked up on that, too, providing further evidence that something was brewing when he
The option activity takes place in absence of any known or substantiated news event, such as an upcoming earnings report. First Data is slated to report earnings on April 19, just one day before the April options will expire. Buying options three weeks prior to an earnings release would be a very premature way to play on earnings. The time decay over the next three weeks would be a heavy headwind that would require the company to deliver a blowout number for those calls to turn a profit. To view a quick video breakdown of how to hunt out unusual activity, click here.
this article , technology has made the job of sussing out unusual activity a lot easier but its application much more difficult. Electronic trading allows parties that might be privy to, or have a hunch about, a possible takeover to execute a fairly large option order quickly and, more importantly, anonymously. In the past, when orders needed to be worked in person on the trading floor, not only did it take longer to execute the transaction, but it also was transparent as to who was doing what. For example, was the trade truly an outright new purchase of out-of-the-money calls as opposed to a spread or liquidation? This made unusual volume a more valuable and reliable tool for identifying takeover candidates or stocks in play, but the information was confined to a small group of people. Now, with intraday activity disseminated in real time, it's much easier for almost anyone to use basic software or simple tools to screen for unusual volume. The problem is that as people start piggybacking on the transaction, the volume swells further and draws even more people into what might not be a predictive or valuable trade. In less-liquid issues, a simple newsletter recommendation that has nothing to do with a takeover can suddenly spark a buying frenzy, and the stock is in play. And given that takeovers and private money buyouts have come with increasing frequency and are probably the biggest driving force for big price moves, a list of names with "unusual activity" can run to 20 or 30 a day. Clearly, the majority of these will not be takeovers or even profitable trades. So, given the huge possible returns, it only takes one good winner to pay for the multitude of losers that never pan out. And many people still think it's worth it to chase down unusual option activity, however slim the evidence. But always remember the old caveat: buyer beware.