Schaeffer's Trading Floor Blog

The Reverse-Line Movement of the VIX

Dissecting supply and demand in May VIX options

by 5/1/2014 7:15 AM
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In sports handicapping, there's a phenomenon known as "Reverse Line Movement." Or, so they tell me. It's said to happen when the majority of bets are tilting to one side, yet the line is moving the other way. For example, let's say 75% of bets are on the Warriors versus the Clippers, yet the Clippers have moved from 3-point to 4-point favorites. It's an indication that "sharp" money is probably on the Clippers, and the casinos are reading that and lifting the spread accordingly.

Anyway, just wondering out loud if we're seeing the same phenomenon in CBOE Volatility Index (VIX) options lately. Volume and open interest remain robust. Here's a snapshot of how the VIX options board looked about two hours into yesterday's trading. (Click on the charts below to enlarge.)

VIX Options Board on Tuesday, April 29

By that point, 32,000 May 18 calls had already traded. They have just under three weeks remaining until expiration and are more than $4 out of the money, which makes them exactly the sort of option the world loves to own in VIX. Also, check out the open interest in all those VIX out-of-the-money (OOTM) calls. It adds up to about 2 million options from the 15 strike to the 23 strike. Remember, that's just May, and there's a good chance they all go to wallpaper.

There's clearly no shortage of demand here. Yet, prices are declining, and I don't just mean time decay. The VVIX uses the VIX methodology to index implied volatility on VIX options. And it's acting quite poorly as of late.

Daily Chart of VVIX Since April 2013

It's sitting at its lowest levels since the pre-Christmas VIX-blahs at the end of 2013, and basically the second lowest level in the past year.

Now, the VVIX isn't a perfect (what is?). The VIX options board is heavily skewed to the upside, thanks to that perpetual demand for dollar-cheap paper. So, VVIX can overstate at times when the VIX moves. So, to partially account for that, here's a look at VVIX/VIX over the past year.

Daily Chart of VVIX/VIX Since April 2013

And by this metric, the VVIX looks even uglier. The VIX itself was lower in December, so this VVIX drop is more than just VIX-skew magic.

So yes, it's the volatility index options equivalent of reverse-line movement going on here. Everyone still wants to play for/hedge against VIX upside, yet they're getting better prices. Someone's meeting that demand and then some.

"Sharps" don't always win in sports, and they don't always win in investing, either. It's an interesting contradiction in VIX world, but I wouldn't go crazy reading much into it. I tend to believe smart money is better at knowing something will happen, like, say, buying calls ahead of a stock merger. It's much trickier to know something won't happen. And, this is essentially a "won't" bet here -- a wager against a VIX lift in the next month or so.

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

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