Major VIX Action Suggests Volatility Is Going To Decline
Major VIX Action Suggests Volatility Is Going To Decline
The VIX has been front and center in the financial news lately with all the volatility that’s hit the market the past couple weeks. The collapse of the Chinese economy is spooking investors and adding a sizeable level of uncertainty to US financial markets.
As a reminder, the VIX (S&P 500 Volatility Index) is a measure of implied volatility levels on S&P 500 options. As many of you know, the VIX is often considered the market’s fear gauge. 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.
With all the action in the markets lately, there’s been renewed interest in volatility – or volatility products. 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 can check out this article to learn more about why volatility is important.
With that being said, let’s take a look at some 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…
A major VIX put spread hit the tape this week expiring in September. More specifically, a trader purchased the September 19 puts and sold the 14.50 puts at the same time for a total premium cost of $0.29. The spread was done 45,000 times, making the total cost of the trade $1.3 million.
The max profit for the trade is realized if the VIX closes at 14.50 or below on September expiration. That would be actual profits of almost $19 million in the best-case scenario!
Okay, so what’s the story with this VIX trade?
Here’s the chart of the VIX:
The VIX is still trading well above the 50-day moving average after spiking in mid-August. While the benchmark volatility index is off its highs, it’s still trading at elevated levels compared to where it’s been for most of the year.
The trader behind the large September spread is obviously betting the VIX is going to come back to earth sooner rather than later. If the VIX falls to the 50-day moving average, the price will be right in the middle of the spread’s profit range.
So, given the recent history, how likely is it this VIX spread will be a winner?
Given how fast the VIX can move, there’s reason to believe the trader will make money on this spread. While I don’t expect the VIX to go back to 14.50 in roughly the next three weeks, falling under 19 is a definite possibility.
Doing a put spread like this where you’re betting on mean reversion in volatility is generally a good idea. While there’s still uncertainty in the markets, the VIX does tend to revert to its mean faster than most equities and indexes. All in all, it looks like a smart trade.
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.
Category: Options Trading
