Schaeffer's Trading Floor Blog

Breaking Down a $5 Million VIX Trade

One big trader bought 40,000 April VIX calls

by 12/16/2013 7:19 AM
Stocks quoted in this article:

Somebody's bunny looks like he has an opinion on the CBOE Volatility Index (INDEXCBOE:VIX). This, via Bloomberg:

An investor bought $5.12 million in call options that will be profitable if the Chicago Board Options Exchange Volatility Index (VIX) jumps at least 50 percent in the next four months.

The trader purchased 40,000 April calls on the VIX with a strike price of 22 for $1.28 each, according to Trade Alert LLC. The bullish volatility bet was the biggest single block of options to change hands on U.S. exchanges, the research firm said. The VIX rose 0.8 percent to 15.54 [Thursday].

Investors are positioning for a possible jump in volatility with stocks poised for the biggest annual advance since 2003 after the Federal Reserve refrained from reducing monthly bond purchases. The central bank may begin reducing its $85 billion of monthly bond purchases at its Dec. 17-18 meeting, according to 34 percent of economists surveyed Dec. 6 by Bloomberg, up from 17 percent in a Nov. 8 poll.

"Customers continue to hedge their stock-market risk by buying upside calls in the VIX," Mark Caffray, who brokers contracts on the index for clients at Chicago-based PTR Inc., said in an interview. "There have been very aggressive customer buyers of VIX calls in March 23, April 24, and today April 22 call strikes," he said. "We do not expect this activity to subside until a Fed decision on tapering."

I agree with the last paragraph. Everyone's going to stay nervous until we find out about The Taper.

But the implications of a big VIX call purchase are often misstated (in the media at large, not this particular article), if for no other reason than reports of VIX call action literally never include any context. A $5 million investment in VIX calls sounds impressive, but without knowing who's behind it, how do we know if that represents a massive share of his/her portfolio or a mere pittance? Is it a transaction designed to hedge a portfolio, or is a pure bet on a market implosion or a VIX spike?

And even if we did know more about who's behind the order, and their motivations, we STILL wouldn't necessarily be able to derive much meaning. VIX call volume and open interest always dwarfs VIX put activity. And I'd offer that "unusual" VIX call spikes happen over and over again. And they're not exactly smart money as they've predicted something like 80 of the last three market selloffs. But when the market does sell off, the whole world will go back and find a big VIX call purchase that made big money. Everyone will conveniently forget the other times a VIX call purchase went out worthless. Well, everyone but the buyer of the worthless VIX calls.

But that's really not a fair way to analyze this trade. The owner of these calls doesn't need them to actually close in the money to profit from them. It gives the owner a ton of leverage in the event of any sort of VIX spike between now and April. He now has ammo to sell VIX futures, sell VIX calls, sell index puts, buy SPY's or e-mini's, et, al. Or he has a portfolio that's already long but now has a built-in "stop" of sorts.

My only real point would be not to read much into this trade. It's a common sort of play and it's shown no predictive ability in regards to future VIX action. The public always sees and/or fears a VIX lift; just check out the VIX term structure at virtually any date in the past five years.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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