What’s This Massive VIX Options Trade Telling Us?

| March 28, 2014 | 0 Comments

If you’ve been reading my articles for any length of time, you know I often like to point out unusual options trades.  Typically, once a week I’ll cover a couple trades which are either much bigger than normal or on stocks with historically low activity.

However, sometimes I’ll come across a really interesting trade worth highlighting, above and beyond the normal coverage.

Recently, one of those special options trades occurred on the S&P 500 Volatility Index, more commonly known as the VIX.

Remember, VIX is the benchmark for market volatility and is often called the investor fear gauge.  Basically, volatility is a measure of how worried investors are about a big selloff in equities.  So, the higher the VIX, the more investors are concerned about market conditions.

The long-term average price of the VIX is 20.  Anything above 20 typically implies a volatile market.  However, markets tend to be most comfortable with the VIX at 15 or under.  Since the beginning of 2013, the index has only spiked above 20 four times – and each time was just for a day or two before dropping.

It’s the lack of recent activity above the 20 barrier that makes this recent trade so meaningful.

Here’s the deal…

A trader purchased 150,000 May 22 calls on the VIX while simultaneously selling 150,000 May 30 calls.  This strategy is usually known as a bullish call spread.  Selling the higher strike reduces the cost of the spread but caps the potential gains.

In this case, the entire spread cost $0.53.  That means the trade breaks even if the VIX closes at $22.53 or above on May expiration.  If this VIX continues to hover around 14 or 15, that means the VIX would have to spike nearly 60% from current levels.

What’s most impressive about this trade is the investor dropped nearly $8 million to make it happen.  That’s a lot of cash to wager on such a big jump in volatility.  

However, the upside potential of the trade is huge.  Should the VIX climb to 30 or above by May expiration, the strategy would earn a whopping $112 million!

So if someone with that kind of capital is betting on such a prominent spike in volatility, does that mean we need to worry?  Is there a major selloff in our future?

Perhaps, but remember, it could also be a hedge.  $8 million would be a very reasonable hedge against a multi-million dollar long stock portfolio.  And, recent data suggest VIX calls are actually a cheap hedge relative to S&P 500 puts.

I’d say it’s more likely the trade is a large tail-risk hedge rather than a flat-out bet on an increase in volatility.  Yet, there’s still plenty of global economic and political risk out there.  As such, it definitely makes sense to keep an eye out for trades like this… and it’s not such a bad idea to put on a hedge for your own portfolio.

Yours in Profit,

Gordon Lewis

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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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