How is it possible for some professional traders to make the excess profits they do?
Are they smarter than you? No. (And I’m not just being nice. My experience shows it’s true.) If anything, they just have a little more experience.
Do they take more risk? Definitely not. In fact, they take less.
Are they just lucky? Ummm …I think you know that answer.
So, what is it?
Access to other traders is the single biggest advantage professional traders have, because everything else stems from that. There are two main ways access helps traders: 1) The trader education they get from being around one another, and 2) the trade information they can glean from fellow market participants.
Where do professional traders learn to trade? From other traders. Just like any other profession. Doctors don’t learn how to do brain surgery by watching YouTube videos. Beethoven and Mozart both studied under Haydn (and went on to mentor other composers themselves). Even bricklayers and plumbers study under others first.
This is why I worked for peanuts as a clerk on the trading floor for a few years: access to traders I could learn from.
John and I do our small part to bring you mentorship in these newsletters, videos and workshops. But your network is broader. Many of you take advantage of our MTM Community Chatroom, which is free for a limited time. And if you’re not yet using it, REGISTER HERE. That’s a great network of support to share trade ideas, techniques and to learn new strategies.
Speaking of sharing trade ideas, allow me to share a hack that can give you access to professional traders’ activity …without them ever even knowing. This information comes from observing volume and open interest.
Volume and Open Interest
When options trades are made, they all get reported to the clearing firm, which in turn reports them to the OCC, which then disseminates that data to the public. This all happens within a second or two. In fact, if you’ve paid close attention, you’ve probably noticed after you buy or sell an option, you’ll actually see the day’s volume increase by the number of contracts you traded. (You’re part of the market!)
That’s called volume. Volume is the number of contracts that trade in a particular series, meaning a specific underlying, expiration and price—like the AAPL Apr 9th 175 calls, for example.
Open interest then is the running total of the number of contracts in existence—the number of contracts that have been opened and not closed. For example, let’s say those same AAPL Apr 9th 175 calls just get listed today. There are zero contracts that have been created. Then Joe, a retail trader, buys 5 contracts. Volume, of course is 5. And now there are 5 contracts that have been created. Joe bought them and a market maker sold them to him. If Joe then sells 2 of them to take a partial profit, volume goes up to 7, but open interest goes down to 3. (2 more traded, 2 of the 5 were closed.)
Unusual Options Activity
When big professional traders make trades, the trades are, well, bigger. That’s when we see the volume increase a lot all at once, reflecting the big trade that just happened. (Note, open interest isn’t updated till the following morning.)
These unusually large trades are commonly called “unusual options activity.” Now remember, by and large, most of the time these traders aren’t necessarily smarter than you. But they watch the same stocks and options every minute of every day of every week and focus all their attention on them. They get good at what they do.
So, it is sometimes the case that these option trades in and of themselves move the market for the underlying. Sort of becoming self-fulfilling prophecies to some degree. That’s because when traders buy calls, market makers are the ones who sell them those calls. The options market makers in turn buy the underlying stock or ETF to hedge their directional risk, or delta, to get delta neutral. You can imagine, if a trader buys an unusually big number of calls, market makers have to buy a ton of stock, which can push the stock price higher.
Further—and this can come into play with short squeezes quite often, as well as some other situations—if market makers sell enough calls, they will end up getting short a lot of gamma. When a delta-neutral trader is short gamma, they have to buy more stock to hedge as the stock goes up. When short enough gamma, this can really exacerbate any upward move in the stock, potentially propelling the stock much, much higher. This is called, specifically, a gamma squeeze, and can create a great deal of volatility in a short period of time.
Access does indeed lead to excess profits. Trading is an information game, from sharing knowledge through good old-fashioned word of mouth to extracting information in a clever way from unwitting market participants. It all works.
Trade smart, my friends. And take advantage of your Community.
Founder and President
Market Taker Mentoring, Inc.