Joe Kunkle, head research analyst at Relativity Capital and founder of Options Hawk, on how to use options flow to identify new market opportunities.
Aug. 14, 2020
This article was originally published on Opto – Understand What Really Moves Markets.
Traders that want to identify broad trends across industry groups should be looking at options flow.
Goldman Sachs recently released a report detailing why it’s critical now more than ever for portfolio managers to monitor the options market, which is currently experiencing record volumes, having gained 77% in the first six weeks of 2020 alone.
Investors can gain a lot of insight from options positioning, such as directional expectations, timing of expected moves, and the volatility or magnitude expected for a move. If tracked closely, the impact of large trades often lasts through expiration as market makers adjust their positions in order to hedge their exposure.
This delta-hedging will often exacerbates stock moves further, while gamma is also a contributing factor.
On 5 August, for example, a clear trend could be seen, with several massive trades in large-cap tech firms. Each stock was positioned in upside call spreads for October and November with over $200m net paid. The names in focus were Microsoft [MSFT], Alphabet [GOOGL], Salesforce [CRM], Amazon [AMZN], Facebook [FB] and Adobe [ADBE]. The details of the trades can be seen below:
Source: OptionsHawk Notable Options Database
And then on 8/7 large buyers opened positions in July 2021 call options across these names as detailed below, for over $80M, taking an even longer term bullish view.
Source: OptionsHawk Notable Options Database
There are a few things we can take away from such trades.
First, we can see that they are bullish vertical call spreads that are anticipating upward movement in these stocks.
Second, the positions are expiring mainly in November, so these moves are expected over the next three to four months.
Lastly, in terms of magnitude, we can assess the closing prices of these stocks on 5 August and the upper strike of the vertical to conclude that this large investor sees a 10-15% upside in the stocks.
I believe it’s important to understand the why behind such moves, so I have a better understanding for the rationale of the positioning. All of these stocks have been top performers in 2020 — Amazon’s share price is up 70% year-to-date (through 10 August), Adobe is up 34%, Microsoft is up 32%, Facebook is up 28%, Salesforce is up 21% and Alphabet is up 11% in the same period.
These are also names that are largely centred around the strength of the cloud computing sector, which has benefitted from the pandemic and the resultant acceleration of corporate digital transformation. These stocks are also more fairly valued than other high-flying tech sector peers, such as Zoom [ZM] and Twilio [TWLO], and are therefore deemed a safer way for cautious investors to participate in the tech industry trend.
These companies are all major cash generators with sizeable cash holdings that could look to mergers or acquisitions before year-end as well –Microsoft is eyeing a deal with TikTok, for example. I suspect we could see more deals involving these companies before the year is out.
Indeed, many of these tech leaders are extended near-term and will likely provide better entry on pullbacks when the stocks near 21- or 55-day moving averages. However, pullbacks are opportunities, as positioning suggests new highs will come over the next three to four months.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.
Past performance is not a reliable indicator of future results.
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. View our full disclaimer, here.
*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.