All the Single Options

Dmitry Pargamanik and Will McBride, the cofounders of Market Chameleon, join IBKR’s Jeff Praissman to discuss analyzing single option trades. This podcast is a follow up to their insightful webinar, “Single Leg Option Trades Analysis”.

Contact Information: https://marketchameleon.com/

Corresponding Webinar: https://ibkrcampus.com/webinars/single-leg-option-trades-analysis/

Summary – IBKR Podcasts Ep. 161

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman 

Hi everyone, this is Jeff Praissman with IBKR podcasts. It’s my pleasure to welcome to the IBKR podcast studio from Market Chameleon, Will McBride and Dmitry Pargamanik.  

Hey guys, how are you? 

Dmitry Pargamanik 

Hey Jeff, thanks for having us. 

Will McBride 

Thanks for having us as always, Jeff. 

Jeff Praissman 

Oh, my pleasure. And we just wrapped up our monthly webinar and it’s always great to have you, whether it’s a deeper dive or a different dive into the same subject on our podcast channel.  

So it was a great webinar you guys just did on Single-Leg Option analysis.  

Yeah, let’s kind of just start though with kind of beginning, you know you need a hypothesis. So what type of questions are we trying to answer with Single-Leg Option analysis? 

Dmitry Pargamanik 

So when we look at option volumes, it’s not quite the same as stock volume because underneath the option volume, we have different types of option contracts. We have different expirations, we have different strikes, we have calls, we have puts, so we’d have to look at that volume, break it down and then we start asking ourselves certain questions. 

And I would say the top three questions that I usually have are what are people doing? And why might they be doing it? How is it impacting the markets and is there a trading opportunity?  

Now to answer those questions, we’re probably going to have a lot of different questions to lead up to those answers. But those would be the top three questions that at least I have and that we typically see. And just to get to that point, what we cover is what type of questions can you ask to get there? 

Jeff Praissman 

And with any analysis, obviously data is the key core point of that. So for Single-leg option analysis, what data points are you guys concentrating on? 

Dmitry Pargamanik 

So there are two types of data analysis that we do. First you want to collect the raw data that is observable, and it will be things such as time and sales, the open interest, the volume of the trades, the price of the underlying, the price that things traded at.  

And you take that data, you input it into your database and you go through a process that you have to clean the data, prepare for analysis, process it and bucket it, and then use that data to run it through a different model that answers different types of questions. 

And there could be simple questions that you could just run summary statistics, like what is the thirty-day average volume and you could compare that to today’s volume, if you take the daily average versus today. And then you could make a comparison if today’s volume is high or low, for example.  

But there are other types of models that they’re not looking only at actual data, but they’re making an inference of this is what is most likely going on. And an example will be a model that may say that most of the trading in this option are retail investors and they are targeting this option. And you can make an inference because of this news. Or this newsletter that came out.  

Those are models that are based on inferences because we don’t have that exact data point of everybody’s name and their intent. But we could kind of infer it from the trading and the trade size and how they’re coming in.  

So those are the things that we typically do. Take that raw data and run him through models. Different models that try to answer different questions. 

Jeff Praissman 

That’s a really good point you’ve just made because you started off describing actual data,  such as time and sales, open interest, volume, the price of the underlying during the trade. Like all those are in black and white, actual data points.  

And I really like the fact that you started discussing inferred as well because, for example, if something traded mid-market, right, like if you trade on the bid, you can easily say the person sold. If you trade on the ask, you can kind of say that the trader came in and bought it off the market maker.  

But what if it traded mid-market with this inferred data?  

How do you look at something like that if it’s a $1.00 or $1.10 and it traded at $1.05? What are some key points that you can look at after the fact to sort of make an educated guess or give yourself better odds of inferring which way they went? 

Dmitry Pargamanik 

That’s a good point. A lot of our customers, we look at the order flow. Are the orders coming in from the buy side or the sell side? Because then you get an idea of how people are using options. Because every trade has a buyer and seller, but we’re trying to infer what was the initiating order coming in, right? Into the market. 

In your example, if we just use the bid and offer and assume that that was the broker-dealer quote, okay, let’s say we determined that that was the broker dealer quote and that traded mid-market.  

Well, there’s no way to know if the incoming order from that is just coming in to buy or sell, but we can use other data points to try to infer that.  

For an example, we could take a look at how did the trades and the prices tick prior to that? So for example, if we see that there is a trend where every trade is ticking up, the implied volatility, the price, and this happened to continue on that path, then we can infer that there are buyers pushing up the market. Even though it traded in the mid-market, we could compare it to prior ticks.  

We could also compare that to ticks post-trade.  

Another way to make that inference is by looking at the options at that moment surrounding that particular contract. We could look at the strikes below, the strikes above and make an inference by where the implied volatility is trading relative to where the implied volatility levels are set with the options surrounding. For example, the corresponding put, the call above or the call below. 

And by doing that analysis, we could many times draw a conclusion or an inference that this is the most likely order flow moving in the direction of either the buy side or sell side. 

Jeff Praissman 

And throughout our webinars and podcasts, we’ve discussed Single-Leg Options, Multi-Leg Options. When you’re looking at this data, you see a call, like how can you tell if it’s just that call or how can you tell if it’s part of say like a vertical spread or a calendar spread? 

Dmitry Pargamanik 

Fortunately, that’s one of the details that is provided on the trade tape. When a particular contract is part of a multi-leg contract, that detail is disseminated by the OPRA feed. 

 So if you have a multi-leg trade on a contract, it will tell you this is part of multi-leg trade. The problem is it doesn’t tell you what were the other legs that were related to it. It would be up to you to find it.  

However, for single-leg trades, it wouldn’t be a problem because if it’s not tagged multi-leg it’ll be tagged as like a regular trade or auto execution. And this way it’s easier to section off the single-leg trades. 

Jeff Praissman 

What percentage of overall option orders are single-leg versus multi-leg? 

Dmitry Pargamanik 

When we look at the single-leg versus multi-leg, we could look at it from the volume side of it and from the amount of trades. So for example, one trade could have, one contract or one trade could have 1000 contracts and the volume would be 1000 or 1, but these are two trades.  

And if we look at just the volume, we see that about 55%, overall across the board, 55% are single-leg trades. And part of that is because multi-leg trades involve more contracts, usually. Spread will have at least two contracts, but usually they’re bigger in size.  

If we look at the trades on the typical day, 80% of the orders or the trades are coming from single-leg. And that’s because a lot of smaller retail customers tend to use single-leg trades as their reference. 

Jeff Praissman 

When looking at these single orders, how do you use the trade conditions to sort of help analyze that order as well? Whether it traded on the floor versus electronic, you know, does that kind of help you tell a story as well or kind of help you with your analysis? 

Dmitry Pargamanik 

Yeah, definitely. You could also analyze and section off the trades by their trade conditions. So for example, a floor trade. Well, that implies that that was a negotiated trade that involved human touch.  

It happened through probably a broker who went down to the exchange and tried to negotiate, either with the market makers and the specialists or found the other side and that happens to be a negotiated trade. And we have some of those for trades and they tend to be in bigger size.  

Most orders nowadays, though, do get filled electronically, but even in the electronic world, there are different ways that orders could get executed.  

For example, sometimes you see intermarket sweeps which are aggressive orders, which could also just tell us that somebody was really seeking an execution and willing to sweep the book on the BBOS.  

And then you have what they call price improvement auctions. And those indicate that an order was stopped and flashed to the market makers and specialists to seek a price improvement. And usually they do get a price improvement.  

So instead of an order that could have been marketable and maybe taking the ask or hitting the bid, it may have even received additional price improvement.  

So those are things that we could take a look at, analyze and that helps us to see how things traded in that particular option. Those details are given to us, but we could also create buckets of categories in options.  

And I’ll give you an example where one of the things we do is look at an option, we look at the trade and the quantity of the trade and then we’ll categorize it as, this is typical of a small retail trade.  

Or we’ll take a look at a different trade where we see the quantity looks like this is typical of a very large trader.  

And by creating our own tags, our own categories, now we created these buckets for further analysis so we could compare what our retail traders doing and how they’re using options versus maybe very large traders or institutional sized traders.  

Jeff Praissman 

Once you’ve done all this analysis, how can the investor use this data to help form their trading decisions? 

Dmitry Pargamanik 

The two main ways is once you understand, one of the things is.. you do want to understand, well, how are people using it and how is it impacting the markets? And that may help you find and identify opportunities.  

The other way is to try to improve your own execution quality. So for example, if you’re looking to perhaps do a Buy Write or perhaps an upside call, well, it’s helpful to see where you could generate the best quality execution, the best price.  

Where is there perhaps an implied volatility pump on the bid or where you could get billed at a favorable price for near the midpoint, maybe even near the ask price.  

And that adds up and makes a big difference when you can improve your execution quality and find where the options that are more favorable to what you’re trying to do. 

Jeff Praissman 

Most of our listeners definitely understand market sentiment. Obviously like if this analysis is supporting them to say, like a bullish move or a bearish move. And definitely a lot of them understand execution quality.  

But I want to kind of dive a little bit deeper into that, because it really is important and it’s maybe not necessarily as obvious to some people as it should be.A lot of people look at like commissions and they’ll say, okay, this costs $1.00 to go here, but $2.00 to go there and that’s all they think about.  

But what they’re not really seeing is like this execution quality, so if they’re able to buy the option for a $1.03 at the place that it cost $2.00 versus a $1.07 at the place that it costs a $1.00, it’s actually better to pay the $2.00 and the $1.03 versus a $1.07.  

So why is it so important to the investor? 

Dmitry Pargamanik 

One of the things as, at least professional traders, is that you focus on many things. Your models, your risk management, but execution quality is another component that you keep track of. You keep metrics. And you want to make sure that you’re efficient and that you’re getting good executions.  

And I’m not talking just the commissions, but the quality of the executions and just to give, maybe to give an analogy.  

If I am a real estate investor, and as a real estate investor, I might need a mortgage, so I want to know what are the different terms out there? What are the different rates out there and where do I go to get the best mortgage that suits me or where do I get the best insurance to insure my real estate?  

So those things add up over a long period of time. And the difference could be well if I’m looking at an option that is $1.00 to $1.10 and I want to buy it, I could go and I could buy it for $1.10.  

But if I could find a similar option or I discover that wait a minute, I see that this option on this particular exchange has been trading below the midpoint and it’s been doing it a lot, and I try to direct my order there and I get filled at $1.04 instead of $1.10, that’s a six cent savings.  

It might not sound a lot, but percentage wise it’s almost a 6% savings. If you’re looking at your return on investment, it adds up, especially if you’re doing it over and over and over. 

So the quality of execution is one of the important components that traders will analyze and seek out. And a lot of times you’re willing to even pay to get better quality executions. 

Pay brokers or route orders so you could receive a better quality of execution. And that’s part of that analysis. Well, we’re looking at all the trading activity and there were all these different options and some options are similar, it could be a strike away. If I’m seeking to do something, what type of execution can I expect on this option or that option, if there is a lot of trades going on? 

Jeff Praissman 

Will and Dmitry, this was great. You want to leave our listeners with any final thoughts before I let you guys go? 

Dmitry Pargamanik 

A lot of people get very excited and they want to jump right in, especially when you’re seeing things moving around. But I think it’s important to step back, take your time and really go through your analysis.  

Go through your analysis because that will help you really understand what’s trading, what’s going on and how it’s impacting the markets. Is there an opportunity here? Can I identify what the opportunity is? How do I improve my executions? These are all important aspects or factors that contribute to the success of trading, and I think that if you could step back and go through those steps, you’ll see greater success. 

Jeff Praissman 

This has been a great podcast to go along with a great webinar you guys just did.  

For our listeners, I want to remind them that they can find more content from Market Chameleon on our website under Education. Just look for our contributors.  

Once again, guys, great having you here and I look forward to our next podcast/webinar next month. Thank you. 

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