Deciphering unusual options activity

While many long-term investors typically think in terms of fundamentals, traders often consult price action to understand what may be driving a stock at a given point in time. And unusual options activity can provide key context, as an example from Tuesday shows.

Oil refiner and logistics company Delek (DK) topped yesterday’s LiveAction scan for high call volume, with more than 21,000 contracts changing hands vs. a daily average of 320:

Two calls accounted for 95% of that activity—the June $20 calls and the July $22.50 calls, both of which had volume above 10,000. The main difference between the two is that the open interest (OI) in the June calls was greater than yesterday’s volume, while OI in the July calls was much larger than the volume:

Although the two trades may be unrelated, it’s also possible (especially given their magnitude) they’re related. Also, because the volume in the June call was very similar to its OI, this could be a case of a large trader getting out of an existing position. In contrast, the July call’s higher volume relative to OI suggests it could be a new position. This would imply a trader was “rolling up” a large call position—that is, closing it in the June expiration and re-establishing it in the July expiration with a higher strike price. (Today’s OI totals should clarify whether this was, in fact, what was happening.)

To better understand why a trader may have done that, let’s first take a look at DK’s price chart. The stock rallied more than 5% on Tuesday—its biggest up day since May 22, when it gained 9.8%, but not enough to break it out of the consolidation it’s been in since then:

The weekly inset shows the stock consolidated as it reached a resistance level defined by the stock’s November-February highs.

If we look at a chart of the June $20 call, two things jump out. First, the only other day with measurable volume was May 22. This seems to support the idea that a trader opened a large position in these calls on May 22 and closed most or all of it on Tuesday:

Second, yesterday morning the contract was trading around $0.70—below its May 22 closing price of $1.10—even though the stock was trading slightly higher (around $20).

Besides providing a real-world illustration of time decay, this may also shed light on trade strategy. Let’s assume a large trader was, in fact, rolling up a position from June to July. A trader who initially bought the calls on May 22 was, as of yesterday, sitting on a losing position with seven trading days until expiration—a period that would see the options lose time value at an accelerated pace. The trader may have decided to take the loss on June calls and reopen the position in the July calls. However, that would imply an even more bullish outlook, since the trader bought higher-strike calls.

The flipside of this scenario is that the trader initially shorted the calls on May 22, then bought them back at a profit on Tuesday while re-establishing a similar position in the July $22.50 calls in expectation of continued sideways or downward price action in the stock.

Market Mover Update: The S&P 500 (SPX) closed Tuesday higher than it has on all but nine other days in its history—just 1.7% below its February record close.

Today’s numbers include (all times ET): mortgage applications (7 a.m.), Consumer Price Index (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.).

Today’s earnings include: J.Jill (JILL), Korn Ferry (KFY), Oxford Industries (OXM), RH (RH).

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