Options flow

Table of Contents

Options flow: what is it and why you need it

It is almost impossible to discuss options flow without mentioning options flow data. Options flow data have been described as one of the most underutilized trading tools in the options market. If you are trading with knowledge of options flow, it would be best to put your trading on hold or make time to understand how this strategy works because it could be the reason why your efforts aren’t paying off after so many months and years of trading.

Having mentioned that, without letting any second go to waste, let’s quickly touch on options flow data and how they can impact your trading strategy.

Options flow

What are options flow data?

As we mentioned earlier, this tool is underutilized and sadly, only a handful of options traders are aware of its existence — not to mention accessing it or utilizing it in their trading strategy. To answer the question, option flow data, which is also known as order flow, options order sentiments, unusual options activity, and options sweeps refers to options data that the popular “smart money”, top dogs or “big players” like institutional traders, prop firms or options market makers leverage to “shake things up” the market.

Have you ever pondered on the famous saying that the market has a mind of its own? Unless you are new to trading and are unfamiliar with the financial markets, you will know that the market sometimes makes unexplainable moves that often leave traders dumbfounded.

When such movements happen in the options market, they are tagged as unusual options activities. If you have experienced these movements, you will agree that no trader wants to be on the wrong side of the market when they happen. Why? They whip to through the market and stop trades out of their positions; especially when you have a close stop loss or are using improper risk-reward.

How do options flow impact trading?

Because the “unusual options activity” we mentioned is mostly triggered by the market makers’ activities from behind the scenes, they tend to cause so much rave in the market. In some cases, because of the size of the order or orders been placed, they can cause an unanticipated change in momentum and market trends such as a reversal or a continuation in the direction of the big player’s orders ( either bullish or bearish).

In some cases, such upsets in the market are ephemeral and usually happens within the twinkle of an eye. To give you an idea of how an option order sentiment can affect trades, we are talking about orders that are in the range of hundreds of thousands of dollars to millions of dollars. Imagine having prior knowledge of when these orders are coming in or been alerted almost immediately when they come through. You would have caught the ride in good time and made decent profits before the market settles. Such movements are almost similar to what happens when major news or events are been announced — choppiness.

What is the relationship between options flow and volume?

As we hinted earlier, options flow manifests as a swift increase in market volume and momentum. The million-dollar question is how does the volume affect options flow and vice versa?

Volume (as you may already know) is an important technical analysis tool and it plays a crucial role in helping traders predict the potential direction of an asset ( say stocks, options, or commodities). However, what most day traders don’t know is one cannot rely on volume alone to evaluate the direction in which the market is headed.

In addition to being noisy during volatile market conditions or absent during off-sessions, volumes can also be deceptive. There is such thing as the dark pools; it refers to massive purchases that are mostly hidden from the ordinary traders or the public eye. Most time, such large orders are hidden in private trading exchanges.

However, large-scale orders or options flows are not entirely hidden from the public as the market makers have intended. If you are keen on details and you know your onions, there are always signs or tip-offs when the big players start making their moves.

Options flow

How to use options flow to maximize profits

Spotting an option flow may not be as easy as most traders would have expected. However, it’s also not impossible. With the right education and mentioned, you will be able to tell when the big players are out to play and prepare yourself to be a part of the ride.

Having understood how institutional traders and other top players leverage option flow to cause a buzz in the market, the question you should be asking yourself is how do I use this information in my trades?

Making the most of options flow (data) begins with accepting that the big players or market players have access to some information that is not readily available to individual traders who own small accounts. Think about it, nobody will put in millions of dollars to bankroll a trade if they aren’t sure about the outcome — nobody will play a guessing game with such an amount. Secondly, you must also believe that higher volume that is triggered by options flow will result in higher prices when the flow eventually kicks in.

While some traders will argue that, this believes goes against the basics of both technical and fundamental analysis, it is not common knowledge that options flow almost always trumps technicals and fundamentals. In straightforward terms, options flow can be regarded as an indicator or indication that a big move is coming.

How do I identify unusual options activity or options flow?

Unlike in the past when trading was relatively difficult because of the unavailability or limited access to computers, the internet, and information to real-time information, spotting options flow or usual options activities have been made a lot easier — thanks to the myriad of scanners and screeners out there.

All you have to do is launch your scanner/screener and let it scan for unusual options activities based on the parameters you feed into the scanner. Even though there are free options flow scanners you can use, virtually all charting/trading platforms have them built-in. However, you also have the option of going for paid scanners and screeners.

We are rounding off

While you are at it, have in mind that some screeners don’t require you to input any parameter. However, others require you to cross-reference volume with time and sales to get a clear picture of the potential big move or change In direction of a particular option. Some common indicators that you can use to evaluate the potential of a big move happening include large inter-market sweep orders in one contract, volume/open interest, and high relative volume in OTM or short-dated options.

Before we conclude on this subject, it’s is worth mentioning that every order ( no matter how large or small) will eventually go through a major exchange. As such, dark pools are not entirely invisible in the financial markets as people assume.

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