Most traders are aware of the process known as “options expiration.” It occurs on the third Friday of the month. All puts and calls on stocks expire, and at the close, either you sell the contracts if they have value, or they expire worthless, or you end up long or short the stock for Monday. A LOT of money trades in options and it is a big factor in market movement.

What many people aren’t aware of is the process known as “options unraveling.” However, options expiration is usually a bust, meaning that the Friday of expiration is usually fairly flat from a trading perspective. On the other hand, options unraveling is typically fun to trade.

Over the years, I have refined the definition of options unraveling for our Tradesight subscribers. Basically, it is the process by which traders exit their options positions in the days AHEAD of options expiration before the get stuck close to their strike prices with the largest open interest. In other words, the big money is smart enough to get out of options before they expire and roll their funds to the next month’s contracts. And the dirty little secret is that they typically do this collectively.

The average trading day in the stock market looks pretty much the same. You have the most volume in the first 90 minutes and then sometimes you get a pick up in activity for the last 90 or 120 minutes of the day. Everything in between tends to be lighter volume and more risky, and movement is less likely. Professional daytraders trade the opening 90 and the closing 90 mostly. They want the volume and the action.

When the big options traders want to exit their options positions, it takes the better part of a day, and they typically do it AFTER the first 60-90 minutes of the day to get the daytrader volatility out of the way first. So, this is what you typically see for unraveling:

1) It happens most commonly on the Wednesday of options expiration week, but it can also happen on Thursday or even Tuesday.

2) Market volume will continue to be strong AFTER the first 60-90 minutes of the day as options are unwound.

3) The market will pick a direction after the first 60 minutes and move in that direction through the close, meaning the chance of coming back is light.

4) Once unraveling occurs, the energy has been taken out of the market until options expire on Friday.

So this week was options expiration, and we had a classic options unraveling experience. Here’s the 10 minute ES chart of the week:

Options Unraveling

So Monday was a decent trading day, with range and movement in both directions. Tuesday morning, we gapped down and the first hour (in the square) was flat. Note that after the first hour, volume held up (in fact, unlike other days in the week, the heaviest volume bar is not in the first hour) and the market headed lower, making a decent move down. We had several great shorts work for us. That is clearly an options unraveling move.

Then have a look at the rest of the week. The market moved up in the first hour Wednesday (when the daytraders play); INSERT INTO `wp_posts` (`ID`, `post_author`, `post_date`, `post_date_gmt`, `post_content`, `post_title`, `post_category`, `post_excerpt`, `post_status`, `comment_status`, `ping_status`, `post_password`, `post_name`, `to_ping`, `pinged`, `post_modified`, `post_modified_gmt`, `post_content_filtered`, `post_parent`, `guid`, `menu_order`, `post_type`, `post_mime_type`, `comment_count`) VALUES but look how flat the rest of the day was.

Then Thursday, we got a big gap up and moved higher in the opening hour. Then look how flat it went again!

With the big options players already out through expiration, there’s no energy left in the market. Overall volume was light Wednesday and Thursday.

And that takes us to today, Friday, options expiration. The volume is heavier because options are being converted and sold, but it doesn’t create movement. It’s a wash. And it will all be over after today. Stocks are glued to their strike prices with the biggest open interest, but the story of the market this week happened on Tuesday, and it virtually guaranteed that Wednesday and Thursday would be flat beyond the first hour.

It’s a very useful set of information for a trader to have, and the reality is that most have no idea that this occurs.

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