This Secret Can Help You Profit

I'm gonna share a very useful investing secret with you today. This secret can quickly lead you to the best and fastest-moving stocks on the market. Savvy traders use this secret every day to nail down fast and easy profits. All they do is watch for volume surges for one particular asset. And when there's a big spike in volume for this particular asset, well, it means some easy money is about to be made.

So what is this secret asset that traders watch to find fast, easy profits? It's options.

Don't stop reading! Let me make something clear: I'm not telling you that you should be buying and selling options. That's not what this is about. Like I said earlier, all I'm talking about is simply watching the volume numbers. There's absolutely no risk at all when you just watch stock options trade. But when you see the options trading volume jump higher for a particular stock, well, you might want to buy some shares of that stock, because it's probably about to move...

Now, before I go on, let me briefly explain what stock options are and how they work. This is important if you want to understand how this secret works.

An option is a contract between two investors or traders that gives the owner the right, but not the obligation, to buy or sell a stock at a specific price on or before a specific date, or the expiration date. Stock options are an asset, just like stock in a company is an asset. And you can buy or sell stock options just as easily as you can buy or sell a stock. Millions of stock options trade every day.

It's important to understand that a stock option is a contract between two people, and like any contract between two parties, the terms of the agreement are spelled out in the contract. And when you buy or sell an options contract, you are automatically agreeing to the terms. One thing you probably know about contracts is that they have a start date and an end date. With options, that start date is when the options contract is bought. And the day the contract ends, or expires, is called the expiration date. With options contracts, you can find expiration dates that are just a few days away, a week or two away, or as far away as two or three years.

The other important aspect of the option contract is the price at which the contract states that the underlying stock can be bought or sold. This is the strike price.

Now, there are two types of options contracts: call options and put options. A call option gives the owner the right to buy the underlying stock (shares of stock) at a specific price on or before the specified expiration date. Think of it as "calling" the stock to you.

A put option gives the owner the right to sell the underlying stock at a specific price on or before the specified expiration date. Think of put options as letting you "put" the stock to someone else. Put options are roughly equivalent to a short position on a stock. Put options gain in value when the share price of underlying stock goes down.

For this article, I am only concerned with call options. So we're not going to worry about put options right now.

Why Investors Buy Options

Traders and investors use stock options to cheaply control large amounts of stock. I say they "control" the stock because they have the right to buy the stock if they want to.

Let's say a trader buys an August 60 Microsoft call option. That means the trader can buy 100 shares of Microsoft at $60, and he or she has until the third Friday of August to decide if he or she wants to actually do that. If Microsoft shares rally to $70 before the expiration date, and you have the contractual right to buy it at $60, well, that would be good, right?

(Quick note: one option contract is good for, or controls, 100 shares of stock. And, up until a few years ago, all options contracts expired on the third Friday of the specified month. That's changed now — they offer contracts that expire at the end of every week. But to keep things simple, I'm just referring to how it used to be.)

OK. Whew. I hope that explanation wasn't too long-winded. Let's move onto the meat of this article: why you should watch for surges in call option buying...

I just told you that if a trader buys an August 60 Microsoft call option, he or she has the right to buy Microsoft at $60. It might cost a few hundred bucks to buy this contract. Clearly, the trader would only buy this call option if he or she thought Microsoft was going to go higher in price, right?

Right.

But here's the thing that's special about using call options to buy stock. First, you don't have to actually buy the stock. You might think, "Hey, I think Microsoft is going higher, and I'd like to own it. I'll buy a call option." Then if Microsoft actually does go higher, you can "exercise" your option, buy the stock, and lock in the profits. If it doesn't, no big deal — you don't buy it, and all you lose is the couple hundred bucks you spent on the option.

But more important than that, when you exercise an option and buy a stock, the transaction takes place after the market closes. A "buy" order is never issued, so no one, including those high-frequency trader bastards, can screw with you. So big institutional investors can accumulate shares of a stock they like without advertising the fact with big buy orders. This can be particularly important if you want to buy a lot of shares in a small company without ramping up the price.

Here's What They Were Buying Yesterday

Over the last week, I've talked about two stocks with you: Oasis Petroleum (NYSE: OAS) and Twitter (NYSE: TWTR). And there was very heavy call option buying on both of these stocks yesterday. I took a couple screen shots so I could show you. Let's look at Oasis first...

Click Chart to Enlarge

The left-most column represents the strike price. Now, if you look to the right side, you'll see two columns labeled "Volume" and "Open Interest." Open interest is the number of option contracts that are outstanding, and the volume column shows how many contracts traded yesterday. You can see that 3,230 contracts traded at the $9 strike price, and 4,602 contracts traded at the $10 strike price.

Those are some pretty big bets that Oasis is going higher by the third Friday in August, perhaps even above $10. It's around $8.50 right now. Could be as much as a 17% move coming soon.

Now let's check Twitter...

Click Chart to Enlarge

Check out the volume at the 18, 18.50, and 19 strike prices. 6,068 contracts traded at the $19 strike price yesterday! And it gets even more interesting, because these options expire this week. Whoever bought these calls is making a big bet that Twitter will make a big move in the next two days.

We'll see how this plays out, but remember to keep an eye on options trading volume on stocks you are interested in. Here's a Yahoo! Finance link that shows you the options page for Twitter, which you might find it useful.

One more thing: I detected some heavy call buying on Alcoa at the 11 and 12 strike prices yesterday. Just a little heads up for you.

Until next time,

Briton Ryle

@BritonRyle on Twitter

An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.