Whether you intend to trade options or not, it’s never a bad idea to quickly scan Barchart’s screener for unusual stock options volume. Mathematically, this screener shows the difference between the current volume and the average volume over the past month, highlighting unusual activity. That’s the first-order principle behind the screener, which is to report the data as it comes in. Unofficially, though, many investors read between the lines.
Potentially, unusual options allow retail investors to understand what the smart money — the professional class of market participants — may be doing with its funds. As the theory goes, the smart money has access to information and resources that the average investor lacks. Therefore, if there is heightened activity toward certain enterprises, it could indicate a potential move is incoming in the open market.
One promising idea to consider is drink and brewing specialist Molson Coors Brewing Company (TAP). On Monday, TAP stock triggered Barchart’s screener for unusual options volume thanks to a surge of interest. Total options volume reached 4,928 contracts, representing a 352.53% lift over the trailing one-month average. However, call volume landed at only 1,417 contracts, while put volume spiked to 3,511 contracts.
However, an investigation into options flow — which focuses exclusively on big block transactions likely placed by institutional investors — reveals a more encouraging picture. Net trade sentiment on Monday stood at $76,200 above parity, thus favoring the bulls. Subsequently, the heightened activity toward put options was for sold or credit-based transactions.
While not necessarily the most bullish indicator, sold puts reflect general confidence that, at worst, the underlying security will not materially erode. That’s because put sellers (or writers) are underwriting the risk that TAP stock in this case will not tumble. If it does, the sellers are threatened with either assignment or the sharp lashing of tail risk.
Using Conditional Probabilities to Potentially Extract Profits from TAP Stock
As intriguing as both unusual options volume and options flow data are, they’re not necessarily the most precise and reliable indicators. Sure, you can play around with put/call ratios and compare implied volatility with historical volatility, but these invariably tend to be mathematical exercises in second-order concepts. In other words, you can’t tell where TAP stock is likely to go by extracting a derivative of its price action.
When it comes to trading (and especially options trading), market participants require much more precise information. Unlike garden-variety investments where success is determined by magnitude (y-axis), with options, the proposed trade must hit profitability thresholds within the prescribed time period. Obviously, all options have expiration dates, thus necessitating a probabilistic mindset.
Now, for practical applications, two types of probabilities exist: derivative and conditional. The former calculates the odds of certain outcomes materializing across the entirety of the dataset’s distribution. The latter utilizes a similar calculation but focuses on a specific subset of the underlying data.
In baseball terms, derivative probabilities are akin to a player’s batting average last season. On the other hand, conditional probabilities equate to the batting average when there are runners in scoring position (RISP). For options traders, this is a much more useful statistic.
However, in order to calculate conditional probabilities, the dataset must incorporate a unified language. Unfortunately, fundamental and technical analysis both utilize floating metrics. Therefore, when probabilities are utilized in these methodologies, they’re by nature derivative — and I would argue (perhaps controversially) misleading.
Market breadth sequences — or sequences of accumulative and distributive sessions — are, in contrast, binary and consistent temporally. This metric is essentially a representation of demand, which can be easily categorized, quantified and utilized for conditionally probabilistic analysis.
Quantitatively, what stood out about TAP stock is that, right now, it’s riding a 2-8-D sequence: two up weeks, eight down weeks, with a net negative trajectory across the 10-week period. Notably, in 59.09% of cases, the following week’s price action results in upside, with a median return of 3.12%.
Should the implications of the 2-8-D pan out as projected, TAP could breach the $51 level soon, within a week or two. Over the next five weeks, if the bulls maintain control of the market, they could attempt to push the price in a range between $52 and $53.
An Aggressive Call Spread to Consider
For those who want to roll the dice, the 50/52.50 bull call spread expiring July 18 could be a tempting idea. This transaction involves buying the $50 call and simultaneously selling the $52.50 call, for a net debit paid of $100. Should TAP stock rise through the short strike price at expiration, the maximum reward clocks in at $150, a payout of 150%.
The attractiveness of this trade centers on the implied shift in sentiment regime. As a baseline, the chance that TAP stock will rise on any given week is only 48.45%. However, the flashing of the 2-8-D sequence lifts the conditional probability to 59%. To extend the baseball analogy, the sequence provides a favorable matchup against the opposing pitcher. If this were a ballgame, the manager would give the batter the go-ahead to swing.
To be clear, the improved odds are merely that — an improved prospect, not a guaranteed one. However, by using conditional probabilities and applying the language of statistical stationarity in the price action of TAP stock, traders can potentially gain an edge.
