How to Analyze Market Sentiment with Options Flow - $SPY Puts

Analyzing ETF flow is a powerful tool to get an idea of institutional market sentiment, even if you don't trade options. To get a better understanding of how options flow provides trader's with insight into market sentiment, let's take a look at the correlation between options flow and the $50 drop in $SPY from 1/12/22 - 1/24/22.

$SPY 1/12/22 Option flow orders 15 minutes into market open via TitanFlow

Just 15 minutes into open, we see 3 aggressive bearish transactions made by smart money, indicating significant downside sentiment over the next couple weeks. We know this to be true for several reasons: strike price, transaction sentiment, size, and expiration.

Strike price: The strike price of the 2 February 18th contracts are over $30 out of the money (OTM). Using an options profit calculator to measure the rate of theta decay tells us that $SPY needs to be down roughly $15 from the $473.5 spot price on January 25th for the contracts to avoid losing value. This tells us that the institution making these transactions has conviction in significant short term volatility to the downside.

Transaction sentiment: We are fairly certain these transactions were bearish purchases because the orders were sent at and above the ask, signaling an aggressive desire to get the orders filled. Institutions are willing to incur slippage (instantly being down in a position due to the bid-ask spread) when they are eager to secure their position.

Size: The size of these orders, each over $1 mil in total premium cost, is large relative to the size of most $SPY flow, which typically sits in a range of $50k to $500k. We also see repeat purchasing, meaning there are several orders of the same sentiment in a short period of time. This is more significant than seeing a single transaction on its own.

Expiration: The expiration of the $440 puts (37 days until expiration) and the $470 puts (9 days until expiration) indicates a belief by the institutions that a potential downside move would likely be a medium-short term trend, as opposed to just a 1-2 day trend that we might see with contracts expiring within a week.

Now that we understand the above $SPY puts are aggressive bearish positions, let's take a look at how $SPY played out on the chart over the following trading sessions.

$SPY Daily chart with 20 SMA (Green), 50 SMA (Purple), 100 SMA (Red), & 200 SMA (Orange)

The day that the bearish $SPY puts were purchased was rather choppy as $SPY tested the 20 day SMA. The next 7 trading sessions, however, saw $SPY tear through every SMA on the chart before finding a low of $421, resulting in a %12 drop from the time the institutions purchased the $440 $SPY puts at $471.

You didn't necessarily need to play $SPY puts or even options to benefit off of the bearish market sentiment indication provided by options flow. Investors and traders alike can use this type of indicator to keep a close eye on their open positions and develop a trading plan for market conditions without getting caught off guard.

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