Enter the “Options Matrix” to Understand How Big Money Trades
My son is hitting his workout phase as he goes through middle school. The kid wants a six pack and some biceps.
So he’s been reading all about how to achieve his goals.
While a person who doesn’t work out would think it’s as simple as doing sit-ups and some curls to develop those muscles, he quickly learned that isn’t the case.
Fitness experts recommend dozens of workouts, even just to develop one type of muscle.
In the markets we all have the same goal — to make money.
But, in the options market, experts use dozens of ways to achieve that goal. Even from the same expected move.
For new traders, we like to recommend simply buying call options and put options. Those are clear directional bets and the easiest to set up.
But when it comes to spotting unusual options activity (UOA), we can’t always tell if the trader has other positions in their portfolio. And those other positions can expose the true intent behind the activity.
Let me explain…
Navigating the Options Matrix
You see, last Wednesday I answered a question about how we identify unusual options activity.
I covered the basics there. But today I want to dive into the deeper challenges of spotting unusual options activity within the options matrix.
The truth is, it’s hard to spot without the right software. And even with the right software, you have to consider all the moves the trader makes to figure out their true intention.
If it weren’t for technology, it would be impossible to track these trades.
That’s why we employ programs designed to spot potential UOA and alert us to what big traders are eyeing.
But it’s worth every penny spent on these programs and every moment of effort…
These are big-time traders, putting millions on the line. And by trading options, they can make quicker gains than by trading a stock, leverage their bets and manage risk. It’s the perfect avenue for sneaking into big trades without tipping off the market.
Of course, this creates the trickiness of spotting them.
With these massive trades, the options activity is like its own matrix of webbed and interconnected positions — sometimes we don’t even know where to look.
And smart traders and hedge funds use dozens of techniques to structure trades and limit risk.
We refer to these simply as spread trades, where more than one trade is tied to a single position.
In other words, while we may see that a trader bought $2 million worth of calls on a stock, we may miss a different position where they sell a bunch of calls, too. If we don’t spot these other legs to the trade, we can underestimate their end goal.
And let’s not forget, sometimes big traders buy calls not for a juicy return, but to actually exercise them to buy the stock later on.
There are dozens of possibilities with every options trade that comes across. Let me show you a perfect example I spotted recently…
How the Smart Money Manages Risk in Options
Last week, one trader simultaneously opened three positions on Las Vegas Sands (NYSE: LVS).
- Bought 35,000 LVS May 20, 2022 $62.50 Calls for $2.33 — an $8.15 million bet.
- Sold 15,000 LVS December 17, 2021 $60 calls for $1.03 — $1.5 million in income to hedge it.
- Sold 8,000 LVS December 17, 2021 $65 calls for $0.58 — another $465,000 in income.
The stock is only trading for around $47. It’s a clearly bullish bet on the stock to rise about 40%, but it’s not exactly what it looks like.
This trader is rolling out their bullish trades in December, by taking a loss and adding some extra capital to their portfolio. Then, they’re basically doubling down on the idea of LVS surging more than 40% through May 2022.
That leaves them with roughly $6 million in new money at risk — still a hefty bet.
This is where things can get confusing.
Is it their only large bet? Are they rolling out other legs at other strikes?
With a stock as widely traded as Las Vegas Sands, orders for just a few thousand contracts happen practically every day. And there are other strikes with more open interest than the 35,000 contracts that were just opened on the May $62.50 calls. They could easily have more trades open, or add new trades that would get triggered by my UOA radar. But in the end, they would just be managing risk.
Does this trader know something, or are they hedging their bets on the stock to rally over the next 10 months?
This is the kind of stuff I sift through to find the truly high-potential unusual options activity.
Because this trader in LVS likely won’t let an $8 million bet ride by itself here. They will continue to hedge by selling and buying different options.
But it doesn’t mean this info isn’t useful…
With LVS, we still know a trader is very bullish on the stock from now to May. That’s the anchor in their new position. Whether they’re selling calls to protect their downside or not, we can surmise this much.
With this in mind, let’s look at a few more spread trades I spotted last week…
More Smart Money Spread Strategies
I spotted two straddles last week. Straddles are a type of spread trade that involves buying a call and a put for the same stock, at the same strike price, and the same expiration date. They’re good for when you anticipate volatility but aren’t certain about the direction the stock will go. (Mike Carr showed you how these straddles work in a trade he recommended a few weeks back.)
One such straddle was an $8 million bet on salesforce.com (NYSE: CRM) to jump more than 10% in either direction. They bought 3,500 calls and 3,500 puts at the $250 strike price, expiring September 17, 2021.
Same thing on Carnival (NYSE: CCL). A trader scooped up exactly 9,310 calls and puts at the $25 strike price for the September 17 expiration. This trader opted with a strike price above where the stock was trading, with CCL trading around $22.50. By trading higher strikes, they were willing to spend more on the put option, indicating they may lean slightly bearish. But again, by using a straddle, they are simply betting on the stock to make a big move.
Apple (Nasdaq: AAPL) saw a trader place a large bear call spread. This is where you buy one call option, but sell one at a lower strike price for the same expiration. It’s a good strategy for when you’re bearish on a stock but not expecting a massive decline — that’s because buying a simple put option would always give you the greatest potential gains.
They traded the October 15, 2021 calls, buying the $150s and selling the $145s. This spread trade limits their risk and basically allows them to double their money that’s at risk. In this case, they stand to make $880,000 if the stock is below $145 when it expires.
We saw a similar trade on Microsoft (Nasdaq: MSFT), another bear call spread. They bought the October $290 calls and sold the $280 calls, setting them up for a potential $880,000 payday if the stock is under $280.
Selling a call option loses money as the stocks go up. If these traders simply sold the naked calls, without buying the higher strike price, they would ultimately have an unlimited risk on the trade — something you never want to be stuck with.
That’s because as the stock climbs above their strike price they sold, every inch higher from there adds to their losses.
When they buy the higher strike price, they limit their loss on the trade at that point and have a clear risk-and-reward picture. Traders like bear call spreads because it has a very clear risk and reward. They know the stock only needs to fall a few percent for them to basically double their money.
As long as the stock is below the strike price of the option they sold when it expires, they’ll collect the difference between the two premiums.
Accounting for Hedges in Unusual Options Activity
This all goes to show — often the smart money is doing far more than placing one-way directional bets. They’re managing capital, after all.
Hedging is a core part of their strategy that we have to factor in when observing UOA.
But with a bit of careful analysis, we can still determine what these big traders are thinking.
In the past, following these trades could’ve landed you a huge payday. Most notable is a major payday from the bank stock rebound back in late June.
Next week, I’ll highlight some more straight bets to give us more short-term trading ideas.
Editor, Quick Hit Profits
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