Not Everyone is Betting on Higher Volatility

One options trader bet on a ceiling for the iPath S&P 500 VIX Short-Term Futures ETN (VXX)

by Adam Warner

Published on Jan 7, 2015 at 9:04 AM
Updated on Jun 24, 2020 at 10:16 AM

If we all got a dime for every call for higher volatility this year, we'd all have a lot of dimes. I definitely enjoy poking fun at all the calls -- and Bloomberg's piece here is full of some more. But in all fairness, this opinion sounds pretty reasonable:

"To Deutsche Bank strategists led by [Pam] Finelli, VIXmoves will widen as risk tolerance wanes among investors and the growing popularity in volatility-linked products intensifies swings.

"The strategists expect moderately higher volatility on balance for 2015, with the VIX mostly remaining between 13 and 18 and readings above 30 possible at times. The VIX averaged 14.18 in 2014, down from 14.23 in 2013 and less than half the level in 2009, data compiled by Bloomberg show."

I'd agree. Mid-teens will be typical, with a few pops. I don't believe this is THE perma-move to higher volatility. But again, we're getting volatility pops in rapid fire these days, so it does make you wonder. At least, it makes me wonder. This guy, via OptionMonster? Not so much:

"A large trader is betting on a cap to volatility by selling calls in the iPath S&P 500 VIX Short-Term Futures Note.

"optionMONSTER systems show that a single trade of 14,716 of the February 53 calls went off for the bid price of $0.95. Open interest in the strike was just 85 contracts before the trade appeared, so it is clearly a new position."

It's important to note that the 53 strike is a mile away. The iPath S&P 500 VIX Short-Term Futures ETN (VXX) is in the low 30s now. As we all well know, VXX tends to drift lower over time, thanks to perpetual contango and the fact that CBOE Volatility Index (VIX) futures all tend to trade at a premium to VIX itself. But none of that is the case now. Here's the VIX term structure (click to enlarge):

VIX Futures Term Structure in 2014

Yup, that's backwardation in the near-term VIX futures. And discounts across the board! VXX partying like it's 1999 … or like it might have partied in 1999, had they invented VIX futures back then.

It's still a ways away before those call shorts can haunt. It's tough to know where we'd need to see VIX to get VXX up into the 40s. It's entirely path dependent. But let's say this current volatility pop picks up steam, and VIX nudges into the 30s within the week. We'd very likely see a 15%-20% lift in VXX, and a consequent explosion in the "volatility of volatility." Long story short, these out-of-the-money calls could really explode even if they don't get particularly close to the money.

But of course, we have no idea about the true exposure of whomever initiated this trade. Maybe it's some entity already standing to benefit in a big way from a volatility surge and a flight to hedge or bet on "tail" risk. We just don't know -- which is why these trades are very interesting to think about, but ultimately tough to base an opinion on.

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


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