The Option Pit VIX Traffic Light Is Yellow: Expect Wild Moves In The VIX.
Hey Traders,
We had another day of the VIX going higher.
As the VIX was oscillating up and down for most of the day, I saw a customer come in with a really unusual order …
This customer stepped in and sold a pretty big VIX strip on Wednesday.
A “strip” is when a trader buys or sells a whole bunch of options up and down.
In this case, the trader sold four puts and four calls:
The trader sold puts at the February 18-, 20-, 21-, and 22-strikes.
Her or she also sold the February 26-, 29-, 35-, and 45-strike calls.
On the net, the trader collected a premium of $12.20 on the sale.
So what is the deal on this trade?
It kind of acts like a straddle when VIX is sitting at-the-money.
But as the VIX moves one way or the other, the trade gets progressively worse:
Because the strikes are so close together on the downside, this one does start losing money pretty quickly if VIX drops fast.
On the upside there is a little more wiggle room, because the strikes are spaced out.
So why do a trade like this?
I am pretty certain that this is not the only leg of the trade.
There is likely the other side of this trade sitting on the traders book that he or she filled as a variance swap against a client.
If it is not a hedge, then this trader is banking on the same pattern we have seen for months …
VIX threatens to break higher or lower, then moves back to the 20s.
If it is a hedge, then the trader does NOT want to be long volatility in his or her book.
This type of trade might seem irrelevant to some traders, but it is not.
A trader that wants to dump his or her long vol exposure is telling you something …
They do not think VIX is going to 50.
They also likely think VVIX (the VIX of VIX) is too high.
So how can you, the retail trader, play it?
I would look at 1-by-2 put spreads, and or broken wing flies using puts.
They can be a good way to get short volatility and still participate if the VIX falls.
I am going to put this spread together for Volatility Edge clients on Thursday …
I will tell you the trade on Friday.
Your Only Option,
Mark Sebastian