The Option Pit VIX Traffic Light is Yellow: Volatility Is Likely To Move Wildly.

Hey Traders,

Boy, did volatility move wildly on Thursday!

The VIX threatened to move down on the day, and then Bullard spoke, and WHOOSH …

Option volume exploded!

In the morning, it was all puts …

But in the afternoon it was all calls.

One whopper of a trade went up later in the day. It’s an interesting one worth dissecting …

The S&P 500 (Ticker: SPX) was down over 100 points at its low, and closed the day down almost 2%.

The Nasdaq 100 Index (Ticker: NDX) had it even worse …

VIX for its part rallied just under 4 points closing 23.93.

The VIX futures curve though …

It is still in a contango …

However it flattened pretty significantly.

That said, I was fascinated by the last of February call buying.

All of the action took place in May, June and July.

The biggest trade of the day was this giant 1-by-5 in October:

A customer sold 10,000 of the October 35-strike calls for $3.10, and they then bought 50,000 of the October 75-strike calls at $0.70, for a net cost of $0.40

This is likely a hedge trade, meaning the trader is long in the underlying (SPX).

And for this trade to make money, this trader will need a significant move higher in the VIX, or at least the perception that there could be a significant move higher.

The long vega (the option’s sensitivity to volatility changes) in this trade could set this trader up to profit if implied volatility (IV) rises, even if VIX doesn’t make a significant move.

And if VIX blows higher, and VVIX (VIX of VIX) goes to 180, the long vega in this trade could set this trader up to profit.

However, in May and June, we saw a couple of decent size 20/35 risk reversals.

They bought puts, sold calls, and bought VIX futures…

This is a bullish trade … but not wildly bullish.

These trades all imply we could be in for months of the same kind of trading we have seen since November…

VIX up to 30,  VIX down to 18,  VIX up to 30….

So we have some mixed messages from the VIX pits …

• • • The two risk reversals are looking for a move higher, but not a crazy move.
    • Or this 1-by-5 is hoping that SPX will rise, and VIX will fall (since it is hedging long SPX)

What does this mean for you?

This is a trader’s market.

If you want to be long, but are concerned about the VIX blowing higher, a long vega trade will let you hedge your long positions, and take advantage of both a VIX explosion, or a VVIX explosion.

When VIX gets really low, look at calls and call spreads … especially if VVIX is below 100.

For now, I think Thursday’s pop will be a one-off event …

However, as Asia once said …

Only time will tell!

Your Only Option,

Mark Sebastian