"Follow The Flow"

From the desk of Steve Strazza @sstrazza

This is one of our favorite bottoms-up scans: Follow The Flow. In this note, what we do is simply create a universe of stocks that experienced the most unusual options activity - either bullish or bearish... but NOT both.

What we mean by this is that we have options experts, both internally and through our partnerships with TheTradeXchange, whereby we do all the digging through the level 2 details and do all the work upfront for our clients, in order to isolate only those options market splashes that represent levered and high-conviction, directional bets.

We weed out all the noise for you in terms of hedging activity and ensure there are no offsetting trades that either neutralize or cap the risk on these unusual options trades. What this leaves us with is a list of stocks that large financial institutions are putting big money behind... and they're doing so for one reason only: Because they think the stock is about to move in their direction and make them a pretty penny.

From there our job is easy. We merely flip through our list of stocks that saw unusual options activity, and using many of the same technical filters we do for our other bottoms-up scans, we simply pick the best of these setups and follow the money flow to fatten our own pockets along with some of the smartest financial institutions. It's a simple concept, really.

Whether the transaction was executed on the bid or the offer matters as well. Which counterparty was the aggressor definitely matters otherwise we wouldn't know whether the trade was a bullish or bearish bet.

For example, a massive amount of put contracts executed at the ask is a bearish bet (all else equal). But, did you know that a bunch of these very same puts executed on the bid is actually bullish? In this scenario, the seller is the aggressor and they are shorting the puts, which is similar to buying calls on the ask and betting on higher prices.

But you don't have to worry about any of that. We're doing this part for you!

All you need to know is that we've designed a list of stocks that some of the largest financial institutions on wall street are either very bullish or very bearish on... and we're going to follow them into these trades. BUT only if they meet our own criteria. 

Due to the nature of the catalysts applied to create these universes of stocks, most of these trades will tend to be on the shorter-term end of the spectrum... we'll typically be looking to take profits a few months out at most.

At the same time, there will be splashes in the options market whereby participants put on "leaps" - or other long-term strategies, which would warrant a longer timeframe setup.

Either way, after running this scan internally for years now, we're confident that we'll find some great trade ideas from these lists - and better yet, they'll come from both the long and short sides.

Just remember, the main idea behind this note is simple, and no different from the other really. We're merely creating a watchlist of stocks that have potential tailwinds, or headwinds at their backs, increasing the likelihood that they will either start to, or continue trending. After all, we need trends to make money... right?

Then, as with any other scan, we apply a series of technical filters in order to focus on the strongest names with bullish options flow as well as the weakest ones that experienced bearish unusual activity in the options market each week.

At the end of the day, the idea for this universe based on unusual options activity is to follow the smart money into some of their largest-conviction trades in hopes to ride these names higher or lower right along with them.

And of course, as with any stock we're in... we'll also have the primary trend at our back.

Here's this week's list of stocks with unusual options activity, powered by our friends at The TradeXchange:

Let's dive right in and see what these contracts with bullish and bearish options flow have to offer in terms of trade setups in the underlying equity: