Most successful traders use a consistent, repeatable process to find trades. My daily process always includes looking for equity options trades, but I start with a broader overall perspective by first reviewing equity, fixed income, metal, energy and foreign exchange markets, volatilities, sectors that may be in play, upcoming economic news, etc. The idea is to use this perspective to help guide me to profitable setups. It’s pretty clear that, as I write this, we’ve had a bumpy start to the year, there’s lots of uncertainty around COVID, the FED tightening, inflation, the state of the economy, etc. and we’re entering earnings season. The VIX is only at 19 with all this uncertainty? I want to own options!
Lots of sectors are on the move. One sector that strikes my interest is Biotechs. Biotechs were off around 25% last year and off to a bad start this year. There are lots of great companies in this sector and with strong balance sheets, winning drugs and strong product pipelines. There are huge opportunities for companies in the sector that continue to develop Covid treatments and vaccines. Mergers and acquisitions activity is likely to pick up as potential buyers see value with this significant move down. There are also a lot of high risk/high reward small- and mid-cap companies that lead to volatile equity prices.
Now that I’ve identified a sector of interest, how do I start to zero in on a Biotech options opportunity? I target unusual options activity (UOA). Remember, we’re competing against some brilliant folks backed by powerful technology that are looking for some of the same opportunities. We’re retail traders, small fish in a huge pond, so it takes a little (sometimes a lot) of work to be successful. I use unusual options activity to find what those brilliant folks are doing and follow right along – they always seem to know something!
What’s the Process For Finding an Unusual Option Activity Trade
I found recent unusual options activity in $XBI, the S & P Biotech ETF. $XBI is good candidate as it holds a large number of Biotech stocks with a wide range of market capitalization and has liquid options. I found $XBI using Masters In Trading Wall Street Wiretapper. Wall Street Wiretapper is an Artificial Intelligence-based system that quickly identifies unusual options activity. The system is powered by a neural network which literally learns over time how to find options activity opportunities. What type of opportunities does the system identify? Opportunities where the actual volatility of the stock will most likely exceed the implied volatility priced into the options. Exactly what we want when trading options – love those situations where the options price in a $2.00 move and the stock moves $6.00!!!
The Wiretapper analytics identified $XBI as one of the top ten UOA opportunities over the last 10 days:
Looking a little deeper, $XBI continues to show up every day on the Wall Street Wiretapper Open Interest scan – so a lot of options volume is being traded relative to open interest:
Take a look at what’s circled in red – the options activity for that strike/expiration was 54 times the amount of open interest; think someone knows something or has an opinion that we may want to follow? $XBI is starting to look more and more like a good trading opportunity.
What Additional Analysis Can Confirm the Trade?
Let’s review $XBI’s price action over the last year using Masters In Trading’s High Value Target Tool:
Notice the red circle – $XBI is near the bottom of its price volatility band, indicating a 3 to 4 standard deviation price move, and a buy signal could be kicked off soon. This is all the additional confirmation I need to start looking for a trade.
How will I Determine What Trade To Take?
I want options in $XBI but I’m not sure on direction. There has been a big move to the downside but I’m not ready to catch a falling knife. There is not much skew in the options to give me a bias (maybe a slight skew to the upside – we’ll discuss this in another post). I want to capture the upcoming volatility indicated by WWT so I’m going to go with the March 18th (I like to buy a little more time) at the money straddle or the 105 call/95 put strangle. I’ll buy the $100 straddle for around $12.85 or the 105/95 straddle for around 8.50. This is a more expensive trade, but I have enough capital allocated for multiple entries. Always have a trade management plan in place before entering the trade!
How To Manage The Trade
Master’s in Trading has a ton of educational resources to help develop a trade management plan. Always paper trade to until your 1,000% comfortable that you know exactly what to do no matter how the stock moves!
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