Why You Keep Losing Money Following Trade Ideas Let's face it, unusual options activity services are popping up left and right.
Back in 2008, there was only ONE other website that wrote on the topic and how it can be used as an indicator to spot potentially very profitable moves in the stock market. Since then, more investors have flocked towards options trading. After all, trading platforms have improved, option liquidity has gotten better, analytic tools are more readily available, brokerage commission rates have dropped and investor education has become more transparent with statistics and not theory FIN888. With that said, it seems like everyone and their mother are now commenting on unusual options activity on social media. Some of them are actually very good... while others are plain awful. Today, I want to talk to you about following these "experts" and why you should probably rethink that idea. I've been hearing too many stories from option investors who simply try to copy "smart money" trades... they receive from social media-and end up losing money. You see, it's not the actual trade idea that's bad... it's the fact that some option investors are receiving the information late-and are chasing trades when the implied volatility is already "pumped" up. In other words, they are putting themselves at a major disadvantage because they "overpaying" on the entry. Let's look at a hypothetical situation involving Green Coffee Company (GCC). During the afternoon, there were rumors that a bottling company might have an interest in taking over GCC... with that said, there was four times usual options volume in the name that day. The order I want to talk about was a 2,000 lot call options sweep buy in the July $135 strike, purchased for $1.63 when the stock was trading $120.95 a share. The previous Friday, GCC had a wild move from $113 and change to over $122 a share. Active day traders that follow this type of action were likely aware that this large call buy on Thursday could be a catalyst to another monster-sized move. Well, as soon as that order hit, option traders started bidding them up and the stock started to move north. Within five minutes, the July $135 calls were trading above $2.00 a contract. Now, if you were quick enough to get in near their original buy price and had low commissions... you were probably a happy camper.
But... by the time some option investors got whiff of this order, they were paying upwards to $2.20 per contract. That's 35% higher than what the smart money paid, and that's if you reacted within six minutes! Keep in mind, these were options that are expiring in less than 40 days and were about $15 out of the money (all extrinsic value). You see, option volatility changes because of supply and demand factors. The greater the demand for an option, the more expensive they become... hence, option volatility rises. Of course, it works the other way around when there is selling pressure-option volatility drops. In this case, the 30-day at-the-money implied volatility was up about 10% in GCC. The following day, GCC's stock price was down a measly.79%, however, implied volatility got sucked out of the options. The 30-day at-the-money implied volatility was down 10%. And those July 135 calls were trading around $1.53 per contract. Now, the smart money would have been down 6% (if they were still holding). However, those traders that chased the trade and bought the options for $2.20 were down 30%. For some option traders, a 30% move against them is enough- for them to close out of the position for a loss. You see the difference? You've got to ask yourself these questions: Am I fast enough to place orders and get filled at a similar price than the smart money? Are my commissions low enough for me to make a quick trade out of this or will I have to hold it for a longer period? Now, if any of these conditions work against you, then copying these trades is going to put you at a disadvantage because you'll probably have to pay up-which means you'll have to hold the position longer for a larger move. Unfortunately, a lot of the time these option trades move quickly after the smart money gets involved. With that said, you need to do a little bit more work to overcome these factors. Often times, it make sense to put on a structured option position or a short premium trade to counter the huge volatility spike caused by these smart money trades. Heck, sometimes waiting a day or two for the dust to settle might give you a chance to get in for better prices. As I mentioned, there is a ton of information on unusual options activity out there. However, if you're simply copying trades off delayed information... you're putting yourself behind the 8-ball.