Order Flow

I often get asked how I choose which order flow trades to follow and which to avoid. Two trades yesterday and today do a good job of illustrating my thought process:

Yesterday, my scanner picked up on a buyer of 25,000 ADT Corp. (ADT) April 43 Calls for $0.25. At the time of the trade, ADT was trading at 34.50, and the trader would need the stock to trade at 43.25 by April expiration to profit on the trade, or higher by $8.75. The trade made no sense to me. Why would a trader risk $625,000 on a trade that needs the stock to rally $8.25 … a somewhat unlikely scenario.

There are much better ways to get long ADT, like buying at-the-money calls. I dug a bit deeper into ADT and found massive short interest in the stock. This means that traders are short the stock and betting that it will go down. My theory is that the trader, with a massive short stock position, bought these calls to protect himself in case the stock explodes higher on a takeover, and this was the cheapest way to get that protection. Regardless, I had zero interest in following this trade.

Today, my scanner picked up on an odd trade in Nike (NKE). The trader bought 7,500 February 94 Calls that expire on 2/13 for $1.22. With the stock trading at 93 this afternoon, the trader would need the stock to close at 95.22 or higher on February 13 to break even on the trade. So why would a trader target NKE calls that expire in two weeks without any known catalysts for NKE?

My theory, and I’m just starting to dig, is that the trader is trying to get NKE exposure for Under Armour’s (UA) earnings release next week. This is an intriguing trade to me. However, this afternoon, NKE looks weak along with much of the market—so for now, I’ll add it to my watch list.

As these trades illustrate, reading order flow isn’t about blindly following into every big order. It’s about spotting the big trades and then digging deeper to try to figure out why the big traders are initiating the large positions.

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