A Large VIX Call Trade Suggests No Panic Is Necessary

| July 10, 2015 | 0 Comments

options strategyA Large VIX Call Trade Suggests No Panic Is Necessary

Over the past couple weeks, we’re finally getting to see why the VIX is often called the ‘fear gauge’ for investors.  There hasn’t been a lot to be concerned about this year until recently, so the VIX has been mostly running at low levels.

Lately though, the markets are experiencing a genuine increase in volatility.  The VIX actually spiked to around 20, the first time since January.  And, the benchmark volatility index is holding above 18 as of this writing.  That’s below the long-term historical average, but certainly high relative to the last several years.

As a reminder, the VIX (S&P 500 Volatility Index) is a measure of implied volatility levels on S&P 500 options.  Broad market volatility is most commonly tracked by watching the VIX.

If you’re interested in learning more about the VIX, the CBOE VIX mini-site has a ton of valuable information on the index.  Follow the link if you want to learn more.

By the way, trading volatility – or volatility products – has become extremely widespread.  I’ve often written in the past about volatility and options trading.  Feel free to check out this article to learn more about why volatility is important.

In a nutshell, there are two events driving the surge in volatility.   First, there’s the looming possibility of a Greek exit from the Euro.  Plus, the stock market crash in China is also a cause for concern among investors.

Obviously, these are both scenarios rife with uncertainty and drama.  Investors hate drama.  The potential spillover from Greece and China into US stocks has the crowd clamoring for protection.

With volatility spiking higher, is it time to run for the hills?

Let’s see what’s going on in VIX options this week to get a clue…

A trader sold 40,000 July 30 calls for $0.22 apiece.  That works out to $880,000 in premium collected.  The trader will be able to retain the entire premium if the VIX closes below $30 by July expiration.

Okay, so what’s the story with this VIX trade?

Here’s the chart of the VIX:

large trade in VIX options, a chart of VIX

As you can see, the VIX not only is trading well above the 50-day moving average (red line), but also is substantially above the 200-day moving average (green line).  The 200-day moving average has also held as support on days the VIX has tried to pullback.

It looks like the crowd is not yet willing to let go of their concerns.  Once again, relative to recent years, the VIX is currently trading at high levels.  If we trade over 20 for any length of time, then we really know investors are scared.

So, given the recent history, how likely is it this VIX trade will be a winner?

What makes this trade interesting is not the probability of success, but what the trade is saying about risk.  Most deep out of the money calls expire worthless, so the trader is almost certainly going to retain the entire amount of collected premium.

However, there’s generally a ton of risk associated with selling upside calls in the VIX because of how it spikes in times of volatility.  The fact the VIX is already much higher than usual is yet another warning sign.

As such, I think we can look at this sizeable call sale as a reason to be less concerned about a major market selloff.  No one is going to sell 40,000 upside VIX calls if they feel the Greece/China scenarios are going to only get worse.  In fact, this is as good a sign as any that this may be a good buying opportunity for US stocks.  (I wouldn’t ignore portfolio hedges though, just in case.)

Yours in Profit,

Gordon Lewis

Note:  Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com.  You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.

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Category: Options Volatility Watch

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Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.

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