What is Net Flow?
The Net Flow tool on our platform is an area chart. An area chart is a graph that combines a line chart and a bar chart to depict quantities changing over time visually. An area chart allows us to compare several variables over time. For the Net Flow tool, we’re tracking the put premium, call premium and the underlying ticker's last price over time. Below is an example of the Net Flow chart on the Quant Data platform. Remember that this tool updates dynamically in real time, allowing you to see the put and call spikes as they occur.
In the Net Flow chart above on SPY for November 2nd, 2022, the red activity represents the put premium for SPY. The green activity represents the call premium for SPY. The blue line is the current price of SPY. The X-axis is the market day across 15-minute intervals. The two Y axes include premium and the underlying reference price. Hovering over the lines on the chart will provide specific data about the point you are hovering over.
Why should I use Net Flow?
Countless theoretical research studies have empirically affirmed the price-predicting capability of options activity on the stock market. The information content of options activity is the outcome of high-leverage opportunities and minimized downside risk. Knowing that options information is valuable, we must create tools to extract actionable insights from the information-rich data feeds. For that reason, we created Net Flow to track all optionable tickers' real-time put and call activity. By tracking every transaction in the U.S. options market, we can see where the entire market, including smart money, is positioning live. We even account for your transactions in the Net Flow chart!
Elevated put and call activity allows investors to read the level of informed trading present in the options market. In the research paper, The information content of option ratios, B.M. Blau et al. investigate the price-predicting capability of the ratio between put and call activity on the stock market in the short term. The results were astounding, showing that relational put and call activity contained price-predicting information in the short term. Now that we have affirmed why Net Flow should pique your interest, let’s delve into how we can use Net Flow to understand the impact of this information.
How do I use Net Flow?
Let’s explore how we can use Net Flow to read the information content of the options activity. When the put-to-call ratio increases, it indicates fear in the underlying, whereas if the ratio decreases, it indicates confidence in the underlying. This means that when call activity rises in relation to the put activity, we can expect increased confidence, and when put activity rises in relation to call activity, we can expect increased fear. With this in mind, we can utilize abnormal put and call spikes on the Net Flow chart to identify when the market activity increases in fear or confidence. Below I share some observations I made while researching and analyzing Net Flow data.
Observations:
Spikes indicating reversal points are most effective. For example, a large call spike after a drop will likely result in a reversal. A large call spike as the underlying pushes is less informative than the contrarian scenario I previously described.
Filtering by an OTM moneyness type yields more significant results. I will not go into much detail about the reasoning behind this. However, I am more interested in the abnormal OTM spikes due to transaction cost differences in the context of varying volatility scenarios.
A significant spike in both calls and puts indicates increased volume but reduces our ability to observe a directional bias. Additionally, this scenario does not significantly change our put-to-call ratio, making it less important. The same applies to a spike that is evenly broken up amongst the ask-bid. These are likely large multi-leg orders that may not necessarily hold a directional bias.
On the Net Flow tool, we allow you to filter by expiration date, trade-side, moneyness, and historical data. Moneyness types include in-the-money, at-the-money, and out-the-money activity. When you do not filter by anything, it will show you the put and call activity for every transaction across every expiration date by default for whichever ticker you have selected. I found it useful to filter by an OTM moneyness type, as described in my observations above. I also suggest checking the ask/bid breakdown to see whether the spikes traded on one side or whether it was a multi-leg trade. You can always look at the order flow to see what orders caused the large spike.
Below we will go over a few case studies to show the application of the information I just described in real-world scenarios.
Case Study #1
The image above displays the OTM Net Flow for META on November 1st, 2022. At 12:20 pm, you can see the large call activity spike over $8M. Subsequently, the price of the underlying spiked over $3 before leveling off. As you can see, prior to the call spike, we had dominant call-side activity for the majority of the morning. Another thing to note is that the spike happened after a period of consolidation. There was no corresponding put spike in this scenario which contributed to our bias.
Case Study #2
The image above displays the OTM Net Flow for JPM on November 4th, 2022. At 11:26 am, you can see the large put activity spike over $3M. Subsequently, the price of the underlying dropped $2 before leveling off. As you can see, prior to the put spike, we had dominant put-side activity for the majority of the morning with little to no call activity present. In this example, you can see that the put spike came directly after the peak of the morning push indicating a reversal. There was no corresponding call spike in this scenario which, again, contributed to our bias.
Case Study #3
The image above displays the OTM Net Flow for AAPL on November 2nd, 2022. I included this example to demonstrate a scenario in which indecision in the Net Flow is present. As you can see, there is no clear dominant put or call activity, and there are both call and put spikes that occur within minutes of each other around 10:45 am. Consequently, we see sideways action succeeding the indecisive activity. This particular situation is an example of how the ratio of puts to calls is not drastically changing and therefore is not indicating an increase in confidence or fear.
Don’t forget to check out the Net Flow video here.
Also, make sure you check out our article on using the options heat map here. The heat map allows you to see the activity updating on the chain in real-time. The heat map can be extremely powerful when combined with Net Flow because you can read the concentration of activity and see whether it confirms the resulting strike that you see on Net Flow.
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