Market misdirection

The markets can deliver harsh lessons, but they often save their sharpest rebukes for those who take information at face value.

One common misstep: assuming heavy call volume is “bullish” and heavy put volume is “bearish.” True, calls can be turned into long positions in the underlying stock, while puts can become short positions, but traders who engage in this level of simplification will often miss out on important market dynamics.

On Tuesday morning, Floor & Decor’s (FND) call volume was more than 17 times its daily average (and around 27 times its put volume):

While that qualifies as unusually high call volume—it was near the top of the scan yesterday—it doesn’t tell you anything about where the trades were occurring. For example, big trades in at-the-money options expiring in the next few weeks may represent something very different than trades in far out-of-the-money options expiring in several months.

In this case, while there was plenty of open interest (OI) in FND’s October monthly options (including 1,100-contract positions in the $90 and $95 calls), there was almost no trading in them—or in the November or December options, for that matter. Instead, yesterday’s volume was concentrated in the January and April 2023 options, with the biggest print—1,500 contracts, or more than half of FND’s call total at the time—occurring in the April $95 calls.

First, while this could certainly represent a large bullish position in FND, we can’t forget there were sellers on the opposite side of the trade who may have had a different outlook. But even those inclined to see this volume as a sign of bullish interest should remember that trades executed in options expiring in seven months don’t imply the immediacy of options expiring in, say, four weeks. In other words, whatever options traders thought FND would do, they didn’t appear to think it would happen particularly soon.

Yesterday’s price action in FND certainly wasn’t bullish. Shares were down more than 3.5% at midday—more than three times as much as the S&P 500—and were pressuring their early September lows a little above $76:

Regardless of whether unusual options activity paints a bullish or bearish picture, traders should factor in the time frame that activity implies. After all, trade positioning that implies, say, expectations for a 15% rally in six days is much different than positioning for a 15% rally that can unfold in six months.

Context is always key in the markets, which like nothing more than misdirecting unsuspecting traders and investors with dramatic price moves and volume surges that are not always what they first appear to be.

Today’s numbers include (all times ET): Existing Home Sales (10 a.m.), Fed interest rate announcement (2 p.m.).               

Today’s earnings include: Lennar (LEN), General Mills (GIS), KB Home (KBH).

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