Options on cell phone by Trismegist san via Shutterstock
As a monitoring device, Barchart’s screener for unusual stock options volume presents an important barometer for how the smart money may be positioning itself. By noting both the volume relative to longer-term averages and the overall flow of capital, retail investors can paint a sentiment picture and possibly determine where the market may head next.
One idea to keep close tabs on is United Natural Foods (UNFI). Since the start of the year, UNFI stock dropped almost 15% of equity value. In the trailing month, sentiment has been particularly poor, with the security shedding more than 26%. However, in the past five sessions, UNFI gained 6.05%, potentially reflecting a behavioral shift.
On Monday, United Natural had a strong day, moving up 2.37%. Unsurprisingly, the company represented one of the highlights for unusual options activity. Specifically, total derivatives volume reached 6,709 contracts, representing a 73.85% lift over the trailing one-month average. Further, call volume clocked in at 6,319 contracts versus put volume of only 390, yielding a put/call ratio of 0.06.
On paper, the low ratio indicates that more traders were engaging call options than puts, suggesting a bullish outlook. Barchart’s options flow screener — which focuses exclusively on big block transactions likely placed by institutional investors — confirmed the intuitive reading of the ratio with a net trade sentiment of $124,800 above parity.
What’s intriguing is that the biggest transactions by dollar volume overwhelmingly stemmed from call options. Since Barchart’s algorithm identified the sentiment as bullish, it would imply that the calls represented debit-based transactions, meaning that UNFI stock would have to reach established profitability thresholds for the underlying trades to be successful. That’s “directly” bullish in my book.
To be fair, interpreting options flow — or any options-related info — is a tricky matter. Absent interviewing the traders involved, you’re never 100% sure of the strategies and motivations behind the transactions. That said, the quantitative signal seems to back up the bullish case for UNFI stock.
As insightful as reports on the derivatives market may be, they’re still very much interpretive. While arguably better than the traditional methodologies of fundamental and technical analysis, these reports still lack specificity. For traders (especially options traders), a thesis cannot merely be centered on the magnitude component (y-axis); it must also consider the time element (x-axis).
In other words, options traders live in a world of probabilities. To survive and thrive in this ecosystem, statistical analysis is necessary but the practice is difficult to conduct in the financial realm. Initially, you might think it’s as easy as taking the frequency of the desired outcome divided by the total number of events in the dataset. However, this approach only calculates the derivative probability or outcome odds over the entire dataset’s distribution.
What we are looking for? We’re seeking conditional probabilities — outcome odds over a specific subset of the data. It’s a much more useful statistic, similar to a situational batting average (such as when there are runners in scoring position) rather than a simple batting average over last season.
By understanding conditional odds, we can use math to determine when to swing and when to wait for our pitch. It’s a beautiful concept that, once you see it, you’ll never want to go back to the typical spray-and-pray approach.
However, calculating conditional odds is a troubling practice in finance because share prices often fluctuate wildly over time. That’s why a conversion process is necessary and market breadth — or sequences of accumulative and distributive sessions — offers an ideal solution. As a representation of demand, market breadth is effectively binary and that lends itself to the categorization of price action as distinct, discrete behavioral events.
For example, in the last two months, the price action of UNFI stock can be converted as a 6-4-D sequence: six up weeks, four down weeks, with a negative trajectory across the 10-week period. Admittedly, this process compresses UNFI’s magnitude dynamism into a simple binary code. But now, distinct demand profiles can be categorized across 10-week intervals, facilitating probabilistic analysis based on the statistical quantification of past analogs.
As it turns out, since January 2019, the 6-4-D sequence has flashed 34 times. In 70.59% of cases, the following week’s price action results in upside, with a median return of 3.62%. Should the bulls maintain control over the next three weeks, investors could potentially see an additional 4.4% of performance tacked on.
Using Friday’s closing price of UNFI stock of $22.76 as an anchor, $24.60 could be a legitimate target over the next three weeks. Given Monday’s strong performance, a push toward the psychologically significant $25 level wouldn’t be out of the question.
Based on the market intelligence above, aggressive speculators may consider the 23/25 bull call spread expiring July 18. This transaction involves buying the $23 call and simultaneously selling the $25 call, for a net debit paid of $100. Should UNFI stock rise through the short strike price ($25) at expiration, the maximum reward is also $100, a payout of 100%.
From a tactical perspective, what makes this trade attractive is the three weeks that traders have for the transaction to work out favorably. Further, the breakeven price for this trade is $24, which is reasonable given the current market price of $23.31.
Another element to consider is the implied shift in sentiment regime of the 6-4-D sequence. As a baseline, the chance that a long position in UNFI stock will be profitable over any given week is 58.53%. While that’s already robust, the 6-4-D adds 12 percentage points of “free odds” in the bullish speculator’s favor.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com
