What's Behind the Mixed Signals from VIX Speculators?

Hedge funds are net long CBOE Volatility Index (VIX) via futures, but VIX call open interest has dried up

by Adam Warner

Published on Feb 13, 2015 at 9:19 AM
Updated on Apr 20, 2015 at 5:32 PM

I noted the other day that it was difficult to read much into the news that hedgies had gotten more bullish on CBOE Volatility Index (VIX) into actual VIX strength. Going with the trend isn't generally the best signal for the rest of us, in my humble opinion. But hey, opinions vary!

"It appears the management team at FRBNY have decided that manipulating the US equity market via selling VIX has run its course (which started when Brian Sack left and Simon Potter took over) . As of this week - there has never been a bigger speculative long VIX position (implicitly bearish stocks). One wonders what the consequences are?"

OK, that site has literally called the End of Days about 10,000 times, so take it with a grain of salt. In the real world, the picture is murkier, as there are other signs that VIX speculation is less robust than futures would indicate. Namely, open interest in VIX calls has waned.

That, of course, directly contradicts the fact that traders are net long futures. Perhaps they're replacing calls with futures? I suppose, but not sure I've ever heard of that sort of positioning. Perhaps it's two separate sets of players; that makes more sense. Anyway, does this add new meaning? Well, per Marketwatch

"Jason Goepfert, president of Sundial Capital Research, says there have been three other times in the past decade that open interest in VIX call options was the lowest in a year at the same time that speculators in VIX futures were net long, or net short to a very small degree.

…Each time, it occurred after the VIX started pulling back from a previous big spike up.

'The other occurrences saw a temporary spike in the VIX as well, but again each time saw the VIX decline in the months ahead,' Geopfert [sic] said."

As Jason notes, it's a very small sample size. VIX calls seem to generate the greatest interest when they are dollar cheap. You can buy a lot of "convexity" for a relatively small amount of money at low VIX levels. And VIX isn't all that low now, at least on a relative basis.

Remember that these calls are on VIX futures, not VIX itself. And they're European exercise, meaning you can't exercise until expiration. When VIX has a strong rally, the underlying VIX future will surely lift -- but it won't fully track the "spot," and will often trade at a discount for the entirety of the VIX pop. But if the rally has receded by the time the calls expire, they close worthless anyway.

But that doesn't mean they didn't make big money for the owner. They will likely explode in dollar value on the VIX pop, giving the holder a chance to sell them, sell futures, buy stocks, or whatever.

So my thought would be that initiating this VIX bull play just isn't as attractive to a spec after VIX has already lifted. He wants to turn a $0.50 call into a $1 call. When it's a $1 call, there's a greater investment (I ran the math on that one) and less chance of a double. At least, it seems like this chance to someone inclined towards this sort of play.

That's my best guess for the contradiction. Throw it all together, and I don't see a great market tell. Maybe it's just a combo that we see late in a VIX move, which would explain Jason's numbers.

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


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