It's 9:55 a.m. ET yesterday, and the markets look like a nice shade of green. And then I get this in an email.
July VIX hovered in the low 17s in early trading on Tuesday, meaning that these calls were about $5 out of the money when they traded.
The buyer timed his VIX purchase quite well. Here's how the market looked yesterday morning.
Chart courtesy of TD Ameritrade
Pretty good timing on these VIX calls. The proceeded to drop about $1.50 in pretty much a straight line over the next half hour, then another $0.50 a half-hour later.
Someone's bunny has a good nose!
Generally speaking, we tend to overreact to large VIX call purchases. I say that because they happen all the time. The open interest in July 20 calls is 343,561, for example, and they've probably never been anything but out-of-the-money calls. The general consensus is that some very large players use VIX calls as portfolio hedges and we have to put the size of their dollar commitments into proper perspective. That $11 million might represent a small part of the overall portfolio. So we shouldn't just assume this is a smart-money guy front-running the market. Or a contra-tell either, on the theory that it's a panic-stricken market long. Or maybe just someone who now has tons of ammo to fade general market weakness.
But having said that … yowza, what great timing on that purchase, at least as far as the market action went. As for the calls themselves, they only rallied 10-15 cents or so, but I guess that's not exactly chump change making 10% on an $11 million "investment." I strongly doubt they ever buy these for the flip; rather, it's some combo of insurance and a hedge against future bullish market plays.
It's tough to advise anyone to not get carried away with interpreting VIX call purchases after seeing this one. I would still advise it, though, if for no other reason than the fact that virtually every large trade here involves owning dollar cheap VIX paper that figures to explode on a future VIX rally. And by and large, those bets have worked very poorly over the last five years. We just notice the very good trades and conveniently forget the many bad ones that preceded it.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.