Option Sweep Information Is A Powerful Source Of information For Advisors Who Manage Individual Stock Portfolios
An option sweep is a large option purchase by an institution. The best option sweeps are a large transaction executed at the ask price expiring in a relatively short amount of time at a price above the current stock price. It is helpful if the number of options bought is not a round number, perhaps indicating that the buyer bought all that could be purchased at the time.
Why Is This Helpful?
It often indicates that the buyer may know something that ordinary investors do not know.
Not every option sweep results in a winning stock. It is imperfect information. Traders and stock scalpers buy very quickly and often sell for profits within seconds. They benefit because others respond at a slower rate allowing the traders to sell to the late-comers.
Markets are competitive and some automated trading systems need to be lightning fast in order to make these buys. Most of these trades work for the really good scalpers, but they need to control risk because profits may be 5 to 15 cents on average. One big loss takes away a lot of these profits. Successful traders keep losses very small; they call them paper cuts. You can afford a lot of paper cuts if you win 80% of the time.
Traders often learn to trim and trail because sizeable gains are possible. They may sell 75-80 percent of their original purchase while holding 20-30% with a trailing stop order. Thus they may reap a sizeable gain but if the stock declines, they exit without further loss.
Swing Traders And Intermediate-Term Investors May Benefit
After the initial wave of traders buy and sell, most of these stocks have pullbacks and may be bought by a longer term investor seeking much larger gains. The Najarians are often this kind of buyer. Swing traders are invested for one to four days and intermediate term traders can invest for a much longer period.
What Have I Learned From My Recent Experience?
My experience with these trades is that I have been successful over the past few months on most of the trades. I am not experienced enough to compete with the really fast traders. So far I am a few seconds too slow. However, buying on a pullback has worked really well for me.
My average hold is a day or two. When a stock is really powerful, like Mattel (MAT) has been, I sell a part at resistance and buy it back again at support until the stock loses its power. In a day there may be 6 to 15 new sweep opportunities per day. I have been able to keep high cash positions on accounts while keeping up with the market using this strategy. Square (SQ) has been a marvelous position starting back to $33.00 per share. I bought a large position in both stock and options, traded it multiple times and it has not lost momentum yet.
The most important part of this technique is to manage your risk on every trade. Risk should not be less than one unit of risk for an anticipated three units of return. You figure this out by looking at the stock’s likely support and resistance areas. You can do this with charts, both long term and short term. If you cannot anticipate a larger potential profit than risk you should avoid the trade. One big loss ruins the entire plan.
Another caution is to not avoid poorly performing stocks. Some of the biggest profits have come from turn-around candidates like retailers, energy stocks, and other out of favor companies. This was my first mistake. I attempted to avoid what I believed were high risk trades only to avoid the biggest winners. These institutions we follow often know more than we do. Risk should be estimated by reading the charts and solidified by daily vigilance in risk management.
Even if you manage assets using ETFs and mutual funds, option sweeps are great clues to alert you to sectors that are turning positive before the market catches on.