Breaking Down the 'Biggest VIX Trade Ever'

What is this trader's strategy for spending nearly $2 million on CBOE Volatility Index (VIX) futures options?

by Adam Warner

Published on May 15, 2015 at 9:56 AM

Amid all the excitement this week of ... well, nothing in particular ... we had the "largest CBOE Volatility Index (CBOE) options trade ever"! Yes, on Tuesday, VIX saw a humongous call spread, per Jamie Tyrell’s VIX Sonar Report.

The trader basically bought the June-July 23 call spread twice vs. selling the June-July 17 spread one time. He believes the June portion of the trade is closing -- in other words, it's a roll out of a 2x1 spread, making the initiator long two of the July 23 calls vs. short one July 17 call.

Oh, and he did it many times. Assuming it's a roll, he’s now short 180,000 of the July 17s vs. long 360,000 of the July 23s. It cost him $0.11 per spread ... so a total of $1,980,000.

If that sounds like a lot, well, consider that it's on top of whatever he paid for the Junes to begin with, not to mention that maybe it's a position he’s rolled many times over. It's best to annualize it -- so, we’re talking a $24 million play by that metric.

Of course, we have to assume it's a big player, and he’s only plunking down a modest percentage of his portfolio on this ... or else he’s got a real opinion on VIX! So, what does one accomplish with this sort of play?

Well, VIX itself was higher earlier in the week, but it's near 13 now, so both sides are a ways away from the money. Or so it seems. But remember: This is VIX and these options are on VIX futures, and VIX futures always price in a VIX rally. July VIX is 16.65 as U type, so I assume it was very near 17 when the trade went up -- thus, the small side is actually an at-the-money-ish strike. The trader essentially put on a backspread.

A backspread works great if there’s a quick pop in the underlying. That’s especially true in VIX, as the world loves speculating on out-of-the-money VIX calls. If VIX does pop soon, the July futures will lift a bit and this spread should do well. The trader now has ammo to fade it with VIX sales, SPDR S&P 500 ETF Trust (SPY) buys, or whatever.

On the other hand, a spread like this is a disaster in a grind up. If VIX grinds to the low 20s, he stands to get mauled. That’s unlikely though, as VIX doesn’t tend to grind up.

To me, his biggest risk is time. He needs a VIX pop fairly quickly. If it happens too close to July expiration, the calls just aren’t going to generate enough interest. Twenty-three doesn’t seem like an enormous level for VIX, but requires a nearly 80% pop from our current malaise.

All of which is why it's nice when you can put on backspreads for credits. It always sounds like the next vol pop is right around the corner, but most of the time VIX is a show about nothing. And it's mid-May, so we’re not exactly heading into a seasonally strong time to own vol. Getting the credit at least gives you a small win. But alas, VIX is not your typical option. The skew is positive, so the higher the strike, the higher the vol -- meaning you have to go pretty wide on a 2x1 backspread to get to slap it on for a credit.

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

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