The strategy identifies stocks with unusual option activity, then goes long on these stocks, expecting continued abnormal returns. The portfolio is equally-weighted, updated daily, and held for 50 days.
ASSET CLASS: stocks | REGION: Global | FREQUENCY:
Daily | MARKET: equities | KEYWORD: Option
I. STRATEGY IN A NUTSHELL
The strategy trades stocks with options from the OptionMetrics database, excluding contracts with >90 days to maturity. It identifies Unusual Option Activity (UOA) using volume, open interest, and changes in open interest. Upon detection, the strategy goes long on these stocks, anticipating a price impact and abnormal returns. The portfolio is equally-weighted, rebalanced daily, and positions are held for 50 days. Stocks flagged as UOA by CNBC are sold, as they historically show negative returns. The approach aims to follow informed investors while avoiding false signals.
II. ECONOMIC RATIONALE
CNBC’s UOA signals often fail to reflect “smart money.” The study shows that short-term calls generate higher abnormal returns, while long-term calls tend to underperform post-event. By analyzing total option volume, total open interest, and changes in open interest, the strategy distinguishes genuine UOA from noise. This refined method effectively identifies profitable trading opportunities, capturing market inefficiencies driven by informed investors.
III. SOURCE PAPER
Unusual Option Activity: Is it Smart to Follow ‘Smart Money’? [Click to Open PDF]
George Jiang, Washington State University; Cuyler Strong, Wayne State University – Mike Ilitch School of Business
<Abstract>
CNBC’s “Fast Money” show regularly covers unusual option activities (UOAs) and advocates these trades as “smart money” of informed traders. We investigate the informativeness of UOAs. To examine the impact of CNBC coverage, we further identify UOAs not covered by CNBC. We find that UOAs are indeed informative with significant predictive power of underlying stock returns. However, for UOAs covered by CNBC, there is an immediate overreaction at the time of reporting that is followed by subsequent reversal. Our findings suggest that CNBC coverage has a destabilizing effect on underlying stock prices and investors should not naively follow “smart money”.
IV. BACKTEST PERFORMANCE
| Annualised Return | 13.87% |
| Volatility | 8.1% |
| Beta | N/A |
| Sharpe Ratio | 1.71 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
