Trading Unusual Options Activity: Digging Deeper into Jon and Pete Najarian’s F.R.A.M.E. Method

Trading unusual options activity is about more than looking for outsized options trades. It’s about finding trades that are truly unusual. Trades that indicate there’s something under the surface that only a few people know. Trades that indicate that a player is building a large position in a name. Trades that move markets.

Jon and Pete Najarian have traded unusual options activity for decades. In this time, they’ve refined their process from the floor of the exchange to an all-electronic market—a process they now call the F.R.A.M.E. Method.

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What does F.R.A.M.E. stand for?

The F.R.A.M.E. Method for trading unusual options activity recognizes that there is more to making a profitable trade off of unusual options activity than just identifying and copying a trade based off of unusual options activity.

Jon and Pete’s method has five equally important parts that stretch the length of the trade, from identifying the original trade to exiting your trade:

• Filter to find potential trades.
• Research viability of potential trades.
• Analyze option markets to find the best strategy.
• Make and manage your trade.
• Exit your trade.

Filter to find potential trades

Believe it or not, trades don’t come across the wire and say, “Hey, I’m a trade from an insider. Copy me.” Instead, those trades are mixed in with thousands and thousands of other trades. And in order to spot them, you have to know what to look for.

Market Rebellion’s proprietary algorithm, Heat Seeker^®, scans over 180,000 trades a second to separate the normal from the potentially unusual. Heat Seeker is looking at the public information about the trade: size of trade and price paid, comparing these to open interest, average orders, dollar amount, and activity in the stock market around the same time.

How does a trade pass the first step in our process? The trade has to be larger-than-normal size, bigger than open interest, and a large dollar amount. If the trade occurs on the offer or was extremely short-term, then that’s even more indication of someone’s eagerness to get into a trade and, from our experience, increases the likelihood that it is a knowledgeable insider behind it.

Research viability of potential trades

But even that is the start for us. If Heat Seeker flags a trade as potential unusual options activity, then it warrants further investigation by our team of analysts and traders.

From there, we look at whether there is any reason to conclude that the trade either was or was not UOA. For instance, if there was a large stock trade around the same time, that may indicate that the options trade was paired with a stock trade. Or if the expiration date just so happens to fall the week after earnings, that may be evidence that some insider knowledge is behind the order. But the fact that the trade may not be tied to any particular event isn’t necessarily a deal breaker. In the case of acquisitions or takeovers, there usually aren’t specific dates on the calendar to go by.

Analyze option markets to find the best strategy

Once we are pretty sure that a trade fits our criteria to be considered unusual, we start to look at the broader options market. We know the trade that a potential insider did. But we don’t just copy that trade when we put on our own position.

We tend to prefer in-the-money options over out-of-the-money options, which are the favorite of insiders who know something. Yes, we don’t stand to make as much on an in-the-money call from a ROI perspective as someone who buys an out-of-the-money call, but we give up that potential return gladly in order to have a portfolio that looks much more like probabilistic trades than lotto tickets.

In addition to preferring in-the-money options, we also may enter a spread trade, giving some of the potential upside up. By taking a look at markets and where we want our Delta, Theta, and Vega exposure to be, we increase our probability of success in this trade and in the overall portfolio.

Make and manage your trade

A lot goes into trading unusual options activity before the trade is actually placed, but assuming we identify a suitable strategy for the market conditions, we pull the trigger. Some notes when trading UOA:

• Be more cautious than the trade that triggers your trade. Yes, you can follow the unusual activity trade exactly if you want, but don’t go farther out of the money than the trade that triggered your idea and don’t go closer in time. Again, if this is someone who knows something, then they may have a very good reason for that strike price and expiration date. Frequently, we will be more cautious by going further in-the-money and farther out in time. That way, we don’t have as much extrinsic value lost while the trade plays out.
• Seeing multiple trades trigger as unusual in one name should build your confidence. Frequently, we see the same names or sectors appearing in our UOA filters week after week. The more that a name appears, the more likely there is something behind the trade.
• Don’t hesitate to lock in profits and roll the trade up if it works. Frequently if a name is being acquired by a big hedge fund, the price will continue to move in the direction of the unusual activity. This creates the opportunity to roll up the trade and lock in profits. Do it. Risk management is critical.
• Don’t forget to have a stop in. Just because a trade triggers as unusual activity doesn’t mean that it is a sure thing. In fact, there is no sure things in trading. The acquisition talks that the insider was expecting could have broken down. Or the trade could have just never been insider activity after all. Not all trades will work out as winners.

Exit your trade

If big news does come out in the stock, then you have a clear signal to exit your trade. Let the stock do what it will to incorporate the news and then get out as soon as you can. This is a good thing. Take that capital and deploy it elsewhere. There isn’t a shortage of this activity on Wall Street.