Schaeffer's Trading Floor Blog

The Latest Move by VIX Bears

Bearish bets are rising on the VIX

by 5/14/2014 7:36 AM
Stocks quoted in this article:

The market's rallying….and "VIX heads towards biggest slump in over 4-1/2 years:"

NSE's volatility index, or India VIX .NIFVIX, fell as much as 23.88 percent, heading for its biggest single-day fall since August 26, 2009 after exit poll results showed Bharatiya Janata Party and its allies headed for a majority in elections.

India VIX had surged in the lead-up to the exit polls as investors braced for a potential negative surprise.

OK, it's not our CBOE Volatility Index (VIX), never mind. That particular India volatility surge was akin to a pre-earnings volatility pop in a name that's had some rough reactions in the past. India "beat" the number, and the news is now out, so there's no need to pay up for protection any more.

Here's a development that's more relevant over here.

Large traders and speculators raised their overall bearish bets in the VIX futures market last week for a second straight week and for the sixth time out of the last seven weeks, according to the latest data from the Commodity Futures Trading Commission (CFTC) released on Friday.

The VIX non-commercial futures contracts, comprising of large speculator and hedge fund positions, totaled a net bearish position of -63,466 contracts in the data reported for May 6th. This was a change of -17,980 contracts from the previous week's total of -45,486 net contracts that was registered on April 29th.

The second straight increase in bearish positions brings overall net contracts to the highest bearish level since January 28th when net positions stood at a level of -65,504 contracts.

This sheds a bit of light on the "Reverse Line Movement" we've noted in the VIX recently. Volume and open interest in VIX products has gone up and up, yet futures and the implied volatility on VIX options (proxied best by the VVIX) has drifted. That's somewhat of a sign that "sharp" money is taking another side of the transaction.

This report obviously confirms that -- big traders are indeed selling VIX derivatives.

That's bearish for VIX on the margins, but it's important to put it all in perspective. VIX futures almost always overprice the probability of a lasting VIX lift out in time -- it's a point we mention pretty much every week. VIX options, especially dollar-cheap out of the money options, also overprice the risk of a VIX pop. It makes perfect financial sense for a large player with deep enough pockets to act as a de facto insurance company.

It's a much harder trade for a small player to take on. That's because the insurance model requires both volume and an ability to handle the occasional accident. You need to take in enough premiums to offset the randomly timed "claims" you have to pay out.

So I'm not sure this data represents any sort of grand market call by big and sharp traders. More likely it's just a modestly increased willingness to sell what is almost always an overpriced asset.

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

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