Unusual Option Activity Scanner: Uncover What Big Hedge Funds Are Doing

Options trading screen

My most successful strategy throughout my 18-year options trading career has been using my unusual option activity scanner. Here’s how it works.

When my proprietary options screener alerts me to a trader buying 10,000 calls and risking many millions of dollars, my alarm bells go off. Who is buying these calls, and why is he taking such a big position? Does he have insider information?

This Tripped My Unusual Option Activity Scanner

Jana Partners, Warren Buffett, Carl Icahn and Bill Ackman are just a few of the many hedge funds and institutions known for using options to build positions. Jana recently bought a Whole Foods (WFM) position and pushed for a sale to Amazon (AMZN), then cashed out for a quick $300 million profit.

And earlier this week, it was announced that Jana had taken a stake in Hewlett Packard Enterprises (HPE). Cabot Options Trader subscribers who follow my Daily Order Flow List of unusual option activity know that bullish options trades in HPE have been picking up recently, and the stock was a top-three candidate for a new Cabot Options Trader position.

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It’s certainly possible that Jana was the buyer of these calls made last week:

Buyer of 8,000 Hewlett Packard Enterprises (HPE) November 18 Calls for $0.87 – Stock at 17.75
Buyer of 9,000 Hewlett Packard Enterprises (HPE) January 20 Calls for $0.41 – Stock at 17.75

These trades followed a mid-July buyer of 11,000 August 17 Calls for $0.38.

And the trade that originally brought HPE to my attention was a bull risk reversal trade made in June. Here is that trade:

Buyer of 10,000 November 18 Calls for $0.81 (paid $810,000)
Sale of 10,000 November 16 Puts $0.63 (collected $630,000)
Net paid for the position: $180,000.

These bull risk reversals are a favorite tool for sophisticated hedge funds and are just about the most bullish trade you can execute using options because both components of the trade benefit if the stock heads higher: both the call buy is bullish and the put sale is bullish.

And what makes these trades so profitable (if they work) is that the premium collected via the put sale often pays for the premium paid for the call purchase.

However, there’s big risk in bull risk reversals if the stock were to fall. For example, if HPE fell below 16, the trader would be responsible for buying one million shares at 16. Why? Because when you sell a put, you are assuming the obligation to buy the stock at the strike price you sold, should the stock fall below that strike price. In this case, this trader, which may or may not be Jana, was likely willing to buy the stock at 16, if it were to fall below that level.

Bull Risk Reversals Explained

Here’s how bull risk reversals work.

A bull risk reversal is typically used when a rise in the price of the underlying asset is expected. The strategy usually involves the sale of an out-of-the-money put and the purchase of an out-of-the-money call. The trade has unlimited profit potential to the upside and extreme loss potential to the downside.

For example, a January 20/25 bull risk reversal for a $1 credit would be:

Sale of January 20 Puts, and

Buy of January 25 Calls.

If the stock stays between 20 and 25, the trader collects the $1 credit.

If the stock goes to 20 or below, the trader will be forced to buy the stock at 20.

If the stock goes to 25 or above, the trader will exercise his right to buy the stock or simply sell his call for a profit.

Here is a profit and loss graph of this position:

This risk reversal tripped my unusual option activity scanner.Interestingly, HPE, which has been trading poorly since its earnings disappointment in late May, is not popping higher on the Jana news. So I may stay away unless the stock strengthens or bullish option activity picks up again in the days to come.

Jacob Mintz

Quick Profits, Controlled Risk

Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.

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