The Option Pit VIX Traffic Light Is Red: Volatility is likely to decline.

Hey Traders,

As we head toward VIX expiration, the VIX settled below 20 for the third day in a row.

We also saw a huge uptick in VIX options volume.

The volume has two trends – the same trends we have been discussing.

Short, near-dated vol,  go bananas long.

Longer-dated vol …

Take a look at the VIX curve:

After September,  the curve gets extremely flat.

This means traders are currently expecting almost all the vol future convergence to happen inside 30 days.

Here is what I mean by that …

VIX is 19.69.

The September future, at 23.46, is almost four points higher.

December, three months after September, is only trading 1.8 points higher.

That means I can potentially hold a hedge for 3 months and only experience 1.8 points of futures drag.

And that makes longer term hedging advantageous.

This was the biggest trade of the day, a 1-by-5 roll from November to February…

The trader bought the Nov 35s and sold Feb, then did the inverse on the 75 strikes.

The hedger is trying to avoid decay by keeping his or her duration long term.

In the near term … traders are buying puts in droves:

70,000 puts trading in about two hours, across three months, all at the 21 strike.

Traders are fading futures near term to potentially pay for hedges that are longer dated …

That’s a smart move.

What are you going to do?

Your Only Option,

Mark Sebastian

PS

This is kinda what an OTC variance swap looks like when executed with listed VIX options:

My guess is the dealer is short a swap and wanted to hedge some vega exposure down here.