Sometimes I struggle with developing a “lesson plan” for my students — I could wrack my brain for hours and be no further along than when I first sat down to brainstorm.
Other times, a lesson plan is dropped into my lap out of the clear, blue sky, quite unexpectedly.
This time falls under the latter category.
See, it all started with a regular trip to my local Starbucks …
As I saw the drive-thru line with 15 cars ahead of me, it dawned on me …
Getting my Starbucks order filled isn’t that different than getting my stock and option trades filled …
And both present a unifying lesson in taking the road less traveled.
So today, I’d like to discuss why it’s not always a good thing to follow the crowd … whether at the coffee shop or in the option pit.
So, back to the hellacious Starbucks line …
When I pulled into the drive-thru, there were more than a dozen cars ahead of me, and the line was creeping along.
We’ve all been there — you know how it goes.
Well, some days I’m okay to crawl through a line like that. It gives me a quiet minute to myself, which is usually a welcome break when you have small kids at home and a busy career.
Other times, though, I’m too busy and don’t have time to wait 20+ minutes for a drink.
That was my mindset during my last Starbucks trip.
So, I ultimately pulled out of the drive-thru line, parked my car, put on my mask, and went into the coffee shop.
There was no one inside!
I made my way to the register, ordered my drink, and I was out of there in less than five minutes.
As I walked back to my car, I noticed the drive-thru line had only gotten through two of the 15 cars … I would’ve had 13 cars still ahead of me, had I stayed put inside my vehicle.
That’s the moment it dawned on me — the parallel to trading.
Sometimes it’s worth it to follow the crowd, but other times, there’s a better way than what everyone else is doing.
Parking the Options Car
In the world of trading, an option attracting a ton of volume is the equivalent of our Starbucks.
See, there’s much we can learn from option volume — many times, big block trades tell us where the institutional, “impact money” is landing.
For instance, if I see a crazy hedge put on the Financial Select Sector SPDR ETF (Ticker: XLF), like we saw earlier this week, it tells me a lot about what the big money is thinking the underlying might do.
This “impact money” also plays a key role in my Robinhood Trader strategy, where I’m essentially aiming for “dual-factor authentication” — both small retail investor attention and institutional attention.
When I see both sets of investors circling the same stock, my ears perk up, as this tells me the underlying momentum could have legs.
So on some occasions, it pays to follow the crowd (if only for the insight) in the drive-thru line.
Other times, though, option traders should just park the proverbial car.
What I mean by that is — when everyone else is buying one strike, sometimes it pays to look around and see if there is a better option, both literally and figuratively.
There usually is.
For instance, if the Stock XYZ May 100 call option is seeing crazy-high volume, you might think these buyers know something you don’t …
You may be tempted to blindly follow the crowd and also buy the May 100 call. (Cue the obligatory parental quiz about all your friends jumping off a bridge.)
But I suggest taking a second to shop around, so to speak. (Option Pit’s Queen of the Candlestick Licia Leslie knows what I’m talking about.)
Perhaps the 100-strike call expiring a week later, or even a month later, provides more value in your eyes …
Yes, the longer-term option should cost more due to the added time value priced in, but maybe it’s worth paying the extra premium if you aren’t quite sure XYZ can topple $100 by May options expiration.
Or, maybe the May 98-strike call is a better fit for you … perhaps you fear a round-number ceiling for XYZ shares at the $100 level, and think the stock might struggle to take out the century mark.
What I’m saying is — just because everyone else is honing in on a particular option, doesn’t mean that option suits YOUR outlook or risk appetite.
Peloton Puts Are Poppin’
Let’s look at a real-life example.
Peloton (cicker: PTON) attracted unusually high options volume on Thursday, as the stock shot more than 7% higher on the day, ending at $123.55.
PTON saw roughly 126,000 options change hands — more than double its average daily volume of around 59,000 contracts.
PTON was No. 3 on the list — courtesy of Trade-Alert
Most active was the out-of-the-money (OTM) May 100-strike put, where close to 15,000 contracts traded Thursday.
For context, the second-most active option was the weekly 125-strike call that expired Friday, April 9, with fewer than 4,000 traded on the day.
PTON options volume on 4/8 — courtesy of Trade-Alert
The puts may have been purchased as “options insurance,” to protect a long PTON investment …
Or perhaps they were being bought by bearish traders expecting an earnings miss from Peloton in early May …
Or maybe even by skeptics expecting a pullback as warmer weather and widespread vaccine distribution weighs on demand for the indoor bicycles …
Whatever the motive, one could look at that spike in volume at the May 100 put and think, “Hmm … I wonder if they know something I don’t? Maybe I should ALSO buy that put option.”
Well, you should — IF you actually expect PTON to fall back toward $100 over the next few weeks (certainly possible if we see a big enough earnings whiff before May expiration).
AND if you’re comfortable spending about $2.95 for that option, which was the ask price at Thursday’s close.
BUT, if that philosophy doesn’t align with your expectations for Peloton shares, or if $2.95 seems too steep or doesn’t provide enough value for you, it may be time to park the ol’ trading car and look for an alternative.
The May 105-strike put option is 5 points closer to the money than its 100-strike counterpart, yet costs just about $1.20 more.
Meanwhile, the weekly 100-strike put expiring May 14 — a week before those standard monthly options — costs about 30 cents less than its counterpart that attracted all the attention on Thursday, at just $2.64.
So, if you think PTON is going to drop long before May 21 expiration, there’s really no need to pay for an extra week of time.
If you want more cushion as far as time is concerned, the weekly 100-strike put expiring May 28 — a week after those standard monthlies — would cost you just 50 cents more, with these options commanding an ask price of $3.45 on Thursday.
The point is — you have to find what’s best for YOUR trading, taking into consideration your own technical analysis, fundamental analysis, timeline expectations, and risk appetite.
After all, sometimes the crowd is right and there’s a reason everyone is lining up …
But other times, there’s a better option for you … you just have to be willing to get out of line and take a look.
Your Only Option,