Iceberg orders involve breaking down a sizeable trading order into several smaller limit orders to conceal the true size of the commission and minimise its effect on market prices. Only a portion of the total order volume is revealed in the transaction details, such as Level 2 market data, with the remaining volume gradually surfacing as each smaller order is executed. This technique is frequently employed by large institutions to prevent significant market swings triggered by substantial buy or sell orders. When traders detect these iceberg orders, they can leverage the support or resistance levels they create for short-term arbitrage or strategic positioning.

For instance, imagine a large pension fund aiming to purchase $5 million worth of ABC stock. Placing the entire order at once could drive the stock price up sharply in a short time. To mitigate this, the fund divides the order into 10 smaller limit buy orders of $500,000 each. Initially, only the first order appears in the trading data, with subsequent orders emerging progressively as transactions occur.

Options traders can capitalise on iceberg orders in several ways:

1. Pinpointing Key Price Ranges: Identifying the price levels of iceberg orders often highlights potential market support or resistance zones. Traders can strategically place call or put options at these levels or sell options to earn premiums.

2. Minimising Slippage and Market Impact: By tracking the "hidden" buying or selling patterns of major players, options traders can better time their entries or hedges, reducing the adverse effects of sudden price movements on their positions.

3. Short-Term Arbitrage: When an iceberg order consistently buys or sells at a specific price, traders can deploy option strategies near that level, anticipating a brief upward or downward breakout to capture higher returns.