VIX Options Trader Braces for August Volatility Spike

The market's "fear gauge" historically lags in July, before spiking in August

Jul 13, 2017 at 2:34 PM
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The CBOE Volatility Index (VIX) dipped into single-digit territory earlier today -- hitting an intraday low of 9.93 -- but was last seen at 10.03. This lackluster action just echoes the longer-term trend of the market's "fear gauge." Minus a few pops to the 15 and 16 marks in recent months, VIX has stayed relatively range-bound near multi-decade lows, and could be on track for its lowest average close in history in 2017, according to data from Schaeffer's Senior Quantitative Analyst Rocky White. Nevertheless, one VIX options trader yesterday bet big on a short-term volatility spike.

Within the first hour of trading on Wednesday, two symmetrical 100,000-contract blocks of August 30 and 35 calls changed hands on VIX. Per Trade-Alert, this is a result of a long call spread initiated for an initial cash outlay of $500,000 ([$0.13 premium paid for 30 strike, less $0.08 premium collected for 30 strike] * 100,000-contract spread * 100 shares per contract). Overnight open interest translations support this theory.

If this is the case, the options trader is expecting August VIX futures to surge to 35 by VIX options expiration on Wednesday, Aug. 16. This would result in a maximum profit of almost $50 million for the spread strategist, though they will begin to profit on a move north of breakeven at 30.05 (bought call strike plus $0.05 net debit). Risk, meanwhile, is limited to the initial premium paid.

VIX hasn't printed above 30 since Feb. 11, 2016 -- fueled higher by a Fed-inspired sell-off in global stocks -- and 35 since Aug. 25, 2015. However, a recent VIX options indicator suggested speculators are growing more bullish with their volatility bets, with vertical spreads seemingly in vogue.

Given the current low-volatility regime, it's more than possible that this recent VIX options activity is a result of speculators hedging against another August volatility spike, rather than betting on one, with the weekly Commitments of Traders (CoT) report showing large speculators hold a near-extreme net short position on VIX futures. In fact, as Schaeffer's Senior V.P. of Research Todd Salamone noted in a recent Monday Morning Outlook, "The VIX typically hits its year-to-date lows around the middle of July, before bursting higher into the months of August into October."

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