SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

How Hedge Funds Use Options


Hedge funds and institutions have been using options to get market leverage for years. Warren Buffett has been known to buy calls and sell puts to get bullish exposure, and so has Carl Icahn. And recently I told my subscribers about a massive options trades that shows just how these big investors use options.

Whenever I see trades that I’m not necessarily executing, but that I feel will give my Cabot Options Trader subscribers a feel for market tone, a trade idea or, if nothing else, a bit of options education, I email them a feature I call, “Stocks on Watch.”


Here is an options trade made on June 12th which is a perfect example of how hedge funds use options, from a recent “Stocks on Watch”.


Stocks on Watch: Workday (WDAY)


As I’ve written several times in the last week, option order flow has turned mixed. In fact, all five days last week, bullish and bearish trades were split nearly 50/50. This, along with the many upcoming global events, has kept me from adding new bullish positions.


However, this morning a trader opened a massive bullish position in Workday (WDAY). Here are the details of the trade:

Buyer of 12,500 WDAY January 110 Calls for $23.70 – Stock at 126

This trade is interesting for a couple of reasons.

The $29.6 million of money at risk is clearly a large amount of premium bought. And is the largest single call buy that I can remember in the last month.

Also, with the stock trading at 110, this trader is buying deep in-the-money calls. So why would he pay such a high premium vs. buying calls at the 130 or 135 strike for significantly less?

The answer is all about leverage.

With this purchase, the trader risked $29.6 million in premium. However, he has big upside potential as he is buying-in-the-money calls, which will move almost one for one with the stock. If WDAY stock goes up $2, these 12,500 calls will go up nearly $2. He essentially controls 1.25 million shares because the calls are so far in-the-money.

If the trader wanted to have similar exposure through a straight stock purchase, 1.25 million shares would cost him approximately $157 million.

So the trader gets similar upside exposure to WDAY with the purchase of the calls, but with $127 million less at risk.


Typically traders execute this strategy if they have high conviction that the stock is going higher.


Choosing which expiration date and what strike to purchase when evaluating calls and puts can be overwhelming for beginner options traders. There are seemingly endless choices.


My general rule is that if you don’t have high conviction in a stock’s direction, buy slightly out-of-the-money calls/puts. This reduces your dollars at risk in case your stock thesis is incorrect.


And if you have high conviction in a stock’s direction, much like the WDAY trader, buy in-the-money or at-the-money calls/puts.


And in the past year we have seen similar deep in-the-money trades in Micron (MU), Alibaba (BABA) and Square (SQ). And buying in-the-money calls is a favorite strategy of legendary hedge fund traders David Tepper, George Soros, Carl Icahn and Warren Buffett.


This WDAY trade is what makes the power of options so intriguing. When you use options, you risk pennies to make dollars. Or in the case of hedge funds and institutions, millions of dollars to make many millions of dollars.

 

Jacob is a professional options trader and editor of Cabot Options Trader. He is also the founder of OptionsAce.com, an options mentoring program for novice to experienced traders. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations. Jacob developed his proprietary risk management system during his years as an options market maker on the Chicago Board of Options Exchange and at a top tier options trading company from 1999 - 2012. You can follow Jacob on Twitter.

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • A Global Equity Put Write Portfolio

    Many that sell equity market put options focus on the S&P 500 (SPX, XSP, SPY). Some will add small caps by selling puts on the Russell 2000 (RUT, IWM). An investor could also make their put selling strategy globally diversified by adding MSCI EAFE (EFA) and Emerging Markets (EEM).

    By Jesse,

    • 0 comments
    • 200 views
  • The Random Walk Hypothesis

    The “random walk hypothesis” (RWH) is one idea about how stock prices behave – but only one of many. It is a theory promoted in academia and believed in my many, but not so much by traders involved with handling real money. Theories aside, is the market truly random?

    By Michael C. Thomsett,

    • 0 comments
    • 279 views
  • How To Trade Options Successfully

    I’ve now been trading options for over a decade and been associated with Steady Options for seven years – hard to believe.  Over that period, I’ve learned quite a bit about option trading; how to improve, what not to do, and generally how the option markets work. I’m still learning.

    By cwelsh,

    • 3 comments
    • 528 views
  • January 2019 Performance Analysis

    No one likes losing money, and no one likes hearing "excuses". However, in an effort to be fully transparent, solicit feedback, and to improve our own performance, we're writing this article to do a further breakdown of the losses which our model portfolio incurred in January 2019. 

    By Kim,

    • 17 comments
    • 1,322 views
  • Island Clusters as Strong Reversals

    Options traders constantly seek the elusive reliable reversal signal. A few unusual but strong reversals are worth looking for, and their patterns reveal likely exceptional timing for opening or closing option trades. One example of this exceptionally strong signal is the island cluster (or, island reversal).

    By Michael C. Thomsett,

    • 0 comments
    • 357 views
  • What’s Wrong With Your 401(k)? (If anything)

    There currently are over sixty million Americans that are active 401(k) participants, and well over 500,000 total active 401(k) plans offered by employers in the United States.  Despite these high numbers, usages could be higher, as the US Census Bureau estimates that only 41% of all employees with access to a 401(k) plan utilize it, with even less funding it fully.

    By cwelsh,

    • 0 comments
    • 439 views
  • Upcoming Decay of Options

    I am on the hunt for a short volatility position for three main reasons. First, the market’s wild swings have, for the time being at least, diminished. Second, option activity has dried up as my options barometer continues to be stuck in the 4 – 6 range as traders are not making big bets in either direction.

    By Jacob Mintz,

    • 0 comments
    • 521 views
  • The Scientific Process of Increasing Expected Returns

    For many US investors, the "base case" for equity investing is US large cap stocks, most commonly benchmarked as the S&P 500. You could absolutely do far worse than owning these 500 great US companies, and the weight of the evidence suggests that most actively managed mutual funds that benchmark themselves against the S&P 500 index have in fact done worse.

    By Jesse,

    • 0 comments
    • 906 views
  • Those Golden and Death Crosses

    The use of moving average (MA) for predicting future price behavior must be undertaken cautiously. MA is a lagging indicator, so the question must be: Can a lagging indicator provide guidance for the future? Yes. The use of two MA lines and how they interact is a reliable form of reversal indicator.

    By Michael C. Thomsett,

    • 0 comments
    • 633 views
  • Trading Reverse Iron Condors When IV Is Elevated

    Our members know that pre earnings straddles and calendars have been our bread and butter strategies in the recent years. We enter those trades when the prices are cheap compared to previous cycles. However, in the last few months of 2018, Implied Volatility exploded, making most of those trades too expensive.

    By Kim,

    • 0 comments
    • 706 views

  Report Article

We want to hear from you!


It easily can be a protection of their short positions that they entered a week before. So they are buying ITM calls to make a synthetic put. BTW, the next day after that 26M trade, I saw a bunch of big trades 1-5M which were strangles ;)  

Share this comment


Link to comment
Share on other sites

Absolutely. And this is why you cannot really rely on big options trades to reach any conclusions and base your own trades on them. You never know the real context of "unusual options activity".

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs