Using our options activity algorithm to profit from a gap down too big

The put/call ratio is frequently misleading because:

1) it doesn’t take into account the price of the option being traded (i.e. total dollars risked)
2) it doesn’t take into account if the option trade is an opening (buying) or closing (selling) trade

Our proprietary option algorithm does focus on both of those telling variables. The algorithm also ignores everything in between the bid and ask, and ignores straddles, buy writes, and spreads. Trades occurring at or above the ask (most likely buying/opening trades) carry much more weight in the algorithm than trades occurring at or below the bid (most likely selling/closing trades). The dollar amounts are then kept as a running total every 15 minutes of the trading day. We also factor in the news of the day, and the setup of the daily chart.

Look at the 5 minute chart of IQ and the running totals of options activity from our algorithm (all times PST) below.

IQ gapped down 6% on news BIDU sold a portion of their IQ shares. The options market didn’t care and during the first 5 minutes there was $246,000 in options buys delta (calls – puts). That was our signal to go long IQ at $29.48. Zone 6c (the first 15 minutes of trading) confirmed our long trade. After the first 45 minutes, option selling started to trump buying and the stock drifted lower, but we were already out with a hefty profit on our first trade of the day.

If you aren’t following what the big money is doing, you are trading blind. To get our trades in real time off our proprietary options activity algorithm, we offer a free 7 day trial membership.