What happens when everyone is long stock and they now need to protect that position?
What do they do?
They buy puts. The majority of traders will always be long stock and they can protect those positions with long puts. That way if the stock drops the long puts will offset those losses.
Why do traders care?
When everyone is buying puts to protect their portfolio it makes the price of puts rise. This rise in price pushed volatiles in out-of-the-money puts way over at-the-money options and out-of-the-money calls.
This is an example of a normal volatility curve (volatility smile). Without getting into the specifics it can be seen that the out-of-the-money puts on the left side have a higher volatility than the at-the-money options and out-of-the-money calls.
So what does it mean when we see this?
This means that people are putting more emphasis on the out-of-the-money calls than out-of-the-money puts. People are not protecting against this stock dropping, they think this stock is going to breakout or even get bought out.
Now this doesn’t mean that people are right and we should just buy this stock and wait for the big pay off. Let’s take a look at exactly what people are buying.
The stock in question is QLIK Technologies (NASDAQ: QLIK [FREE Stock Trend Analysis]).
As can be seen here, there is a high open interest in the 37 calls, which indicates a high level of buying at that strike. Now traders can join the crowd and buy the 37 calls which are probably hoping on a buyout, or traders can structure a better and higher probability play.
Setting up a vertical spread on the 33/37 calls is likely a good bet. In this trade, traders should look to buy the lower volatility strike, the 33s, and selling the higher volatility strike, the 37s. This allows traders to put this trade on for a $1.05 debit with a potential reward of $2.95, creating a strong reward/risk setup. The breakeven for this trade should be at $34 with max reward over $37.
Read more: http://www.benzinga.com/trading-ideas/long-ideas/13/08/3847828/how-to-trade-the-weird-option-action-in-qlik-technologies-qli##ixzz2ciPVrDzZ
Written By: Adam Beatty
One of Marketfy’s top-rated opens strategists has profited for the past 6 months with 100% gains, zero losses, a 15% return. Learn the options plays he’s using to generate a profit in his valuable free report: “36 Options Play Every Trader Must Know.” Click here to access his report and start learning the strategy that has allowed him to consistently profit.