Ahead Of Options Expiration, Watch For The Rumors

This Friday is the monthly options expiration for January. Often, many traders experience a lot of volatility during the four trading sessions leading up to the expiration. These sessions will be filled with rumors plus countless upgrades and downgrades. Some of the chatter may be true, however, most will not. That's just one of the ways large institutions move stocks in their favor.

Institutional Movement
Why would they do that? It's simple; the large market-moving institutions know that most retail options traders are simply buying call and put options on the near-term expiration. The retail options trader does that because they're cheap. You see, the further out the option is in time, the more expensive it is for the trader. On the flip side, the closer the option is to the expiration date the cheaper it is. So, the institutional traders will try and figure out the imbalances in the near-term expiration and move the equity in the opposite direction of the majority small retail options traders. For example, if there are a lot of call options bought in a particular stock by a large amount of retail traders, large institutions will drive stocks in the opposite direction and make those options expire worthless or out of the money. That type of action happens during the third week of every month.

How do the institutions know what the small retail options trader is betting on?

Simple, they watch the options chain with sophisticated computer programs to see where the small number of contracts are bought. Large institutions buy thousands of contracts at a time, while the small retail trader buys between one and twenty contracts. Believe it or not, it's not too difficult for them to do. Once they see a large imbalance in a particular equity, they take that stock in the opposite direction. Just look at how many bullish call options there were when Apple Inc. (AAPL) was trading over $700. Soon after that high print, it rolled over by more than 200 points to $505 a share. It is safe to say that those call options expired worthless.

So expect the rumore to fly this week. On Monday there were rumors about Apple Inc, Dell Inc. (DELL) and Hewlett-Packard Company (HPQ) just to name a few. Other leading equities that tend to be volatile during the week of options expiration include First Solar, Inc. (FSLR), Green Mountain Coffee Roasters, Inc. (GMCR) and Netflix, Inc. (NFLX).

Beware The Upgrade/ Downgrade
Traders should also watch for upgrades at highs and downgrades at lows by major banks and brokerage firms. This is another common way the large institutions move stocks in the direction they are betting. Traders should always be on guard this week as options expiration approaches.