While the options market carries a reputation for unique complexities, it can also be a powerful tool for speculation. Thanks to their leverage, traders can utilize debit spreads to bet on relatively small movements in the open market. These valuation swings, however, can translate to massive payouts in the derivatives arena, thus attracting an increasing number of retail participants.
Still, even if an investor had absolutely no desire to trade options, it’s always worthwhile to consider Barchart’s screener for unusual stock options volume. First, unlike many other financial publications, Barchart provides a comprehensive list of securities attracting attention from the big dogs. Second, on a more fundamental note, aberrant transactions can tip retail investors off to potential moves that could occur in the future.
To be clear, it’s not a foolproof mechanism. However, some reasonable inferences can be made. For instance, if traders buy large volumes of out-of-money call options, one can assume that these market participants are bullish. After all, for a debit-based transaction to be profitable, the underlying event that is being speculated on must materialize; otherwise, the trade falls apart.
On Friday, one of the top highlights in Barchart’s unusual options screener was video-sharing and live-streaming platform Bilibili (BILI). Commonly known as the YouTube of China, Bilibili has enjoyed double-digit growth in the first quarter of this year. Further, its advertising revenue is up 20% on a year-over-year basis, reflecting the platform’s accelerating popularity.
Heading into the weekend, BILI stock represented one of the highlights in terms of unusual derivatives activity. Total volume reached 53,310 contracts, representing a 202.57% lift over the trailing one-month average. But at first glance, circumstances didn’t appear encouraging, with call volume only landing at 16,043 contracts, while put volume jumped to 37,267.
Fortunately, options flow — which exclusively filters for big block transactions likely placed by institutional investors — clarified the context. On the final business day of last week, net trade sentiment slipped to $662,100 above parity, thus favoring the bulls. As it turned out, the large number of puts represented sold or credit-based contracts.
Basically, these traders are underwriting the risk that BILI stock will not fall below certain profitability thresholds (of put buyers) by expiration. While it’s not the most directly bullish take on BILI, there’s an underlying assumption of optimism.
Setting Up an Intriguing Trade for BILI Stock
While the fundamental and technical backdrop (via options activity interpretations) appears positive for BILI stock, the challenge is that, for traders, the information lacks specificity. Especially for those interested in trading options, market participants must consider the fact that derivatives expire. Therefore, a proposed thesis must be right in magnitude (y-axis) and in time (x-axis) to be profitable.
Stated differently, traders live in the world of probabilities. They’re not so much obsessed about the “why” of an investment but rather the “how” — how much, how fast, how likely. To answer this inquiry requires statistical analysis. However, merely running probability matrices on financial data is incredibly challenging due to the non-stationarity problem.
Essentially, the measurement metric in finance — whether that be the share price or any number of valuation ratios — fluctuate temporally and contextually. For example, it wouldn’t make much sense to compare a high-flying tech company’s current valuation to what it was valued at several years ago. Much time has passed and along with it, the context of the business and the underlying industry.
To extract usable probabilities — the conditional variety as opposed to the derivative — one must impose stationarity on the target dataset. That’s the number one reason why I’ve been harping on market breadth or sequences of accumulative and distributive sessions. Market breadth is a representation of demand and demand is a binary construct: it’s either happening or it’s not.
Plus, demand is a first-order principle: it cannot be mathematically reduced. Therefore, not only does this metric carry inherent meaning, demand profiles are categorizable and quantifiable, which facilitates probabilistic analysis.
Quantitatively, BILI stock in the past two months printed a 6-4-U sequence: six up weeks, four down weeks, with a net positive trajectory across the 10-week period. Notably, in 62.3% of cases, the following week’s price action results in upside, with a median return of 4.71%.
Last week, BILI stock closed the books at $19.74. If the implications of the 6-4-U sequence pan out as projected, the security could hit $20.67 quickly, perhaps in a week or two. Should the bulls maintain control of the market, past analogs imply that they could push BILI toward the $21 level.
An Enticing Bull Spread for the Aggressive Speculator
With the market intelligence above, those who want to speculate on Bilibili may consider the 20/21 bull call spread expiring July 18. This transaction involves buying the $20 call and simultaneously selling the $21 call, for a net debit paid of $45 (the most that can be lost in the trade). Should BILI stock rise through the short strike price at expiration, the maximum reward is $55, a payout of over 122%.
Primarily, what makes this trade so attractive is the implied shift in sentiment regime. As a baseline, the chance that a long position will be profitable in BILI stock on any given week is only 50%, a coin toss. However, the statistical response to the 6-4-U sequence pushes the odds in favor of the bullish trader.
Finally, the above call spread features about four weeks for the optimistic thesis to work its magic. Even with using past analogs, forecasting for both time and magnitude is an extremely difficult business. Thus, the extra theta gives debit spread buyers a potentially confidence-inspiring cushion.
