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The recent excitement in the volatility market has produced some interesting trades in CBOE Volatility Index (INDEXCBOE:VIX) options. Bloomberg's "Options Beat" highlighted this one on Monday:
An investor sold about $18 million in calls on the Chicago Board Options Exchange Volatility Index, a strategy that will be profitable as long as the VIX doesn't keep extending last week's surge.
The trade included the sale of 250,000 February 22 calls for about 70 cents each, according to data compiled by Bloomberg and Trade Alert LLC. It happened after the VIX reached an intraday high of 18.99 around 12:20 p.m. New York time. The investor will keep the proceeds if the VIX stays below 22 and the calls expire worthless.
Well, the timing sure looked pretty prescient. But we really don't know exactly what the initiator is rooting for.
"It's impressive in size and it's impressive in timing," Henry Schwartz, president of Trade Alert, a New York-based provider of options-market data, said in a phone interview. "Whether it's an outright bet against the VIX rising or hedge against existing positions is hard to say. It's a large account for sure."
And that's exactly right. It's certainly worthwhile to highlight a trade of this magnitude. It's especially interesting that it's a VIX call seller, given that the lion's share of order flow in VIX involves the "public" buying calls. But we really know too little about what went on here to make any market predictions based off it.
Is this a naked call sale? I really doubt it. Even though VIX itself was near 19, VIX February futures were not. I don't exactly know where they were at the time, but I'll guess they were in the 16.5 range. So the calls were significantly out of the money. And quite high in implied volatility terms, I would add. But selling any of these is a lightning-in-a-bottle sort of trade. Any further VIX lift towards the 20's would see them go up 50%, or 100%, or whatever. There's no way to know, as it would all depend on the timing.
I doubt even the largest of players would have that on naked. VIX call volume and open interest keeps trending higher. There's a very good chance the seller of these Feb 22's owns cheaper VIX paper in some form. Maybe he owns a lower February strike; maybe he owns a further-out month. Who knows, but I'm guessing he owns something. Maybe its' a derivatives desk with huge Variance position and this just locks in win.
And this highlights another point. We don't know the size of the player in question, but as Henry Schwartz notes, we can definitely infer it's a large player. It could be someone big enough where a trade like this isn't a gigantic part of a portfolio. The point though is we just don't know, and without knowing, it's hard to give it context and market significance.
In general, VIX call activity is bullish for the market. But that relies on the assumption that most players are naked call buyers, and all those naked call buyers now either have ammo to buy market dips or just the wrong position on for market rallies. So in a vacuum, a trade like this would be bearish. Someone with naked short calls in VIX is at huge risk of a market drop and volatility pop, and would thus have to defend against it by selling into market weakness and piling on a move.
But we don't trade in a vacuum, and the reality is that I strongly doubt it's a naked VIX call sale, and thus I don't expect this trade to foretell anything as far as the market goes.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.