Friday, 22 July 2011
The masses and major media are making it seem that all is well in the markets. Over the past few weeks the Dow and S&P made strongly bullish moves and the Nasdaq reached 11-year highs.
Even with all this positivity, something is very concerning… and it’s not our government’s battle over our debt.
When I was trading on the floor of the exchange, I paid close attention to large orders trading in the option pits. These orders were coming from heavy hitters such as Goldman Sachs, JPMorgan or another large firm. If they were buying huge quantities of put options (which give them the right to sell a stock at a set price), I would trade along with them or find out why they were bearish.
When a big player like Goldman makes a move, it is for good reason.
The knowledge tucked inside these trades is invaluable, but is next to impossible to find. So I want to show you a little trick.
Volume Is the Cause, Price Is the Effect
Volume drives price. When there are more buyers than sellers in the marketplace, prices rise. When the sellers are in control, prices fall.
To find what the “smart money” is doing, some investors monitor large trading blocks of stock to see whether it was a buy or sell order. Unfortunately, the boys on Wall Street have tricks up their sleeves that make it hard for us to know what is really going on.
If a Wall Street player were to place a market or limit order (like most of us do through our brokers) to buy an extremely large quantity of shares, the price might go through the roof or vice versa when they want to sell.
That’s because the trade would be visible to everyone in the market.
The “Smart Money” (hedge funds, top traders, insiders) on Wall Street does EVERYTHING it can to hide its orders. Just like Texas Hold’em, the best bluff with a brain wins… and these guys play every second of every day.
Smart traders are always looking for ways to take advantage of less informed investors. The best hide their buy and sell orders so that they can get in and out unnoticed and without influencing the price of the stock too much.
Back in the ’80s and ’90s, markets were extremely inefficient. There were a slew of ways traders could game the system. Remember, computers and the Internet were still new and not widely used.
Trades happened much slower.
I recall being a trader in the Wild West days of the SOES bandits. These day traders would use lightning-fast computers and skill to take advantage of the Small Order Execution System that was designed to make small trades. They could “hide” and “flash” their orders to take advantage of investors who were trading small amounts of shares in low volume stocks.
Billions of dollars were made by these bandits (and lost by the “little guy”) before the rules and systems were changed.
High-frequency traders can be thought of as modern-day SOES bandits, but the exchanges and regulatory agencies are stepping in to make their lives difficult.
Hiding Out
Market efficiency and technology have improved by leaps and bounds. Today it is extremely difficult to take advantage of “the system.” Most of you have access to tools and information that cost a trader thousands per month.
The one thing that professional investors still do is “hide” their trades. Not in an illegal way, but in a place that most people don’t think to look…
In the option markets!
Options are becoming more and more popular, but are still relatively unknown to the average investor. They are also a great way for a big-time money manager to take a very large position in a stock while having much less visibility and effect on the stock.
To the layman these “smart money” option trades seem to blend in. In my eyes, the option chains tell a story; I can see the irregularities and the trades that often go unnoticed.
Traders Always Leave Footprints
Take Apple (AAPL:NASDAQ) for example. In the month of August, the amount of options currently held is enough to control almost 61 million shares of stock! The average daily volume of the stock is about 14 million shares, which means that August options alone could control almost 4 1/2 days of trading.
Apple’s options started indicating a bearish bias as soon as the earnings report was out and sure enough, the stock has come way off its highs.
But the secret is not just in the amount of shares that options can quietly control, but whether traders are buying or selling them.
The truth lies within something called implied volatility. Options that are being purchased have higher volatility. Ones that are being sold have lower volatility.
By examining this phenomenon called “skew” I can see just how bullish or bearish the “smart money” is. I talked about this gauge in Smart Investing Daily in early June.
Should You Be Concerned?
In my trading service, WaveStrength Options Weekly, I use this data to help find long and short candidates. If the puts are getting much more expensive than the calls, the smart money could be secretly creeping in with a short position. That might give me a bearish bias in the stock.
One index that is seeing this sort of action is the NASDAQ-100 index. The top holdings in this 100 stock index include AAPL, Google (GOOG:NASDAQ), Microsoft (MSFT:NASDAQ), Qualcomm (QCOM:NASDAQ) and Oracle (ORCL:NASDAQ).
The Nasdaq-100 (NDX) has rallied since mid-June, but lately I have noticed there are many more calls being sold and puts being bought. It is not what you would see if the NDX were going higher.
It looks like traders are positioning themselves for a sharp move lower before August’s options expiration date.
If you look at the NDX volatility chart below, you can see the increase in bar size along the bottom that measures the difference between put and call prices; this shows puts (in black) are getting more expensive than calls (in green).
We saw the same pattern in February… just before a March sell-off.
Although it is normal to see skew, I am wary of the recent increase. We may be in for another big sell-off.
These subtle observations can give us a true look at what the market really feels. Right now, I see nervousness.
The phenomenon is taking place in many individual stocks as well.
Another way to think of this would be if a lot of meteorologists and scientists started buying abnormal amounts of hurricane insurance in your hometown.
Would that scare you? Of course it would.
When the insiders make a move… it’s usually a good idea to follow. Or at least dig deeper.
My warning for investors is simple: use caution. Do your homework before jumping into the market at these levels.
Finally, my first ever podcast went live this morning. In it, I talk about one of my most successful moneymaking tactics… buying stock with other people’s money. If you have ever thought about getting paid to buy your favorite stock, follow the link.
Publisher’s Note: Jared will not admit it, but he is one of the sharpest minds in the options industry. How else can you explain his stellar track record and cult-like following?
What’s even better is his dedication to sharing his knowledge. You have seen what he does every week in Smart Investing Daily. It’s impressive. But Jared’s true talent is putting his finger on the best trades of the week. It is exactly why people are lined up for WaveStrength Options Weekly. It is one of our best-selling services… ever.
To read a recent sample of Jared’s work, follow the link.
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Other Related Topics: Investment Opportunity , Jared Levy , Options Trading , Smart Investing Daily , U.S. Economy , Wall Street , WaveStrength Options Weekly
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