Trading Places with Tom Bowley

Fireworks in December? Monthly Options Expire Friday

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The Tuesday before the third Friday of each month gets the blood pumping at EarningsBeats.com. As momentum traders, it's EXTREMELY important to be aware as monthly options expiration approaches. We have seen time and time again how crazy the short-term market action can be when market makers see an opportunity to make literally billions of dollars. Let's not forget that while market makers' primary responsibility revolves around providing liquidity, they're traders at heart. They're looking to do exactly what the rest of us traders are trying to do - outsmart everyone else and profit from their mistakes. When they see low-lying fruit, they cannot resist the temptation. And let me tell you - there's a BUNCH of low-lying fruit right now.

How fast can stocks move during options expiration week? Well, let's take a walk down memory lane, back to October. Zoom Video Communications (ZM) couldn't catch a bid and options traders were piling on. On Tuesday, October 12th, ZM had net in-the-money put premium of roughly $175 million. Lots of options traders were buying put options hand over fist. They couldn't get enough. And why should they worry? ZM looked like this at the close on Tuesday, October 12th:

Was there anything to like on October 12th? I believe there were two things. First, the PPO seems to be worn out to the downside, suggesting that selling momentum was waning. Second, and perhaps more importantly, EVERYONE was betting against ZM heading into options expiration. A simple bounce into options expiration Friday or early the following week would save market makers MILLIONS of bucks short-term. It's not that market makers would lose money if ZM didn't go higher as they hedge, but there's no doubt they'd make much more money if they began to use their capital on the long side and drove ZM's stock price higher. Miraculously, much of that net in-the-money put premium would disappear. We featured ZM on Tuesday, October 12th as a potential beneficiary of options expiration week, calculating max pain - the point at which in-the-money call premium completely offsets in-the-money put premium - at roughly 300. Again, ZM didn't have to move from 255 to 300, but every dollar closer that it moved to that level saved market makers approximately $4 million. So we look at max pain as a directional clue, not a guarantee. It's very important to keep stops in place and manage risk as it is with any trade.

Would you like to see what ZM did after Tuesday, October 12th? Check this out:

If you didn't know anything about options, you'd probably never even give this chart a second look. It's just downtrending, right? Well, except for the timing of that rally. It was a windfall for market makers. ZM rallied 19 bucks in the next two days and eventually reached a high of 291 before resuming its downtrend. It doesn't always happen this way, so I'm not trying to paint a picture of a guarantee. But from my experience, I can tell you this. Downtrending stocks like ZM have the propensity to move higher, because of the huge imbalance between calls and puts.

So which stocks do the market makers have the most interest and incentive in driving higher (and lower) this week and next? Well, that's the topic of our monthly Max Pain event tonight, which begins at 4:30pm ET (the room will open at 4:00pm ET). It's a members-only event, but we offer a 30-day FREE trial. If you're interested in attending, simply CLICK HERE to get your free trial started! We'll send out room instructions to all members later this afternoon.

Happy trading!

Tom

Tom Bowley
About the author: is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market. Learn More
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