Does Recent VIX Action Suggest A Market Meltdown Is Coming?

| August 3, 2015

Does Recent VIX Action Suggest A Market Meltdown Is Coming?

Savvy investors know that VIX options are always worth keeping an eye on.  It’s where the smart money tends to execute important trading strategies and portfolio hedges.  Some of the biggest trades you’ll ever see happen in the VIX options pit.

Of course, the VIX (S&P 500 Volatility Index) is a measure of implied volatility levels on S&P 500 options.  If you’re in to options trading, you probably realize that overall market volatility is most commonly tracked by watching the VIX.

For those who are interested in learning more about the VIX, the CBOE VIX mini-site has a ton of valuable information on the index.  Follow the link if you want to learn more.

Trading volatility – or volatility products – has become extremely widespread.  It’s true for options traders of course.  But, even those traders who never touch options may still trade (or at least follow) volatility levels.

I’ve written a lot about volatility in the past, and you check out this article to learn more about why volatility is important.

With that being said, let’s take a look at interesting VIX action from this week.  It could give us some clues as to what to expect from the market over the next few weeks.

Here’s the deal…

This week, traders purchased blocks of August 20 calls for $0.35 and $0.40 each.  One block was for 20,000, another for 27,000.  Plus, there were blocks of 10,000 and 8,000 at those prices.  For these trades to make money, the VIX would have to close above $20.40 (approximately) by August expiration.

Okay, so what’s the story with this VIX action?

Here’s the chart of the VIX:

vix073015

The VIX recently broke above the 50-day moving average but it was short-lived.  This of course, is after a larger move towards 20.  Nevertheless, the mean-reverting characteristics of the benchmark index are in full effect.

With the drop of the VIX towards 12, very near lows of the year, investors are likely grabbing the August upside calls at what they consider a cheap price.  After all, the VIX could easily get to 20 in a day’s time if something truly severe happens.

So, given the recent history, how likely is it these VIX calls will be winners?

Most likely, the VIX call purchases are not meant to be winners, they’re meant to be hedges.  Short-term upside VIX calls have become one the most popular methods for hedging portfolio risk.  I imagine the August 20 call trades are more of the same.

In fact, compared to the past several weeks, these blocks of calls are considerably smaller than usual.  We’ve seen multiple 100,000 lot trades occur in the same strike or near strikes.  As such, it looks like investors are putting on their usual hedges, but there’s certainly no urgency behind the hedging at this time.

Yours in Profit,

Gordon Lewis
Options Trading Research

Note:  Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com.  You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.

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Category: Options Trading

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also one of the key analysts behind the highly successful Options Trading Wire and Advanced Options Adviser. As a market maker on the floor of the CBOE, Gordon analyzed and traded stocks and options across a broad range of market caps and industries including retail, internet, oil, insurance, and telecom. He often traded thousands of options contracts per month… and it’s fair to say, Gordon’s analyzed and invested in some of the most complex and successful options strategies in the world.

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