Over VIXed

From The Daily Options Report by Adam Warner bringing some sanity to financial news “insight” into their volatility reporting.  The press loves to find causality where there is only correlation.

Here’s a take on today’s VIX move that’s so useless it almost had to come right off the CNBC website.

The stock market’s main fear gauge moved past a key level on Monday, indicating possible troubles ahead for the market.

And one options player with deep pockets is making a big bet that volatility will increase sharply, making this a tumultuous summer.

The Chicago Board Options Exchange Volatility Index, or VIX, moved past 30, a mark it hasn’t closed above since June 4. A VIX reading of better than 30 generally indicates high volatility that usually accompanies stock market drops.

Following suit, stocks lost more than 1 percent.

Oh, where to begin.

There’s nothing “magical” about VIX 30. The move from, say, 29.75 to 30.25 bears no more signficance than say, the move from 30.25 to 30.75. In fact, the VIX is a contrary indicator. Higher levels indicate more fear, on a contrarian basis is actually bullish.

And it’s completely absurd to define today’s action as the VIX lifting and stocks “following suit”. Aside from the obvious fact that stocks were down 1% before the options marts even opened, it’s akin to the logic that umbrellas cause rain.

So what was this big trade? We mentioned it earlier, but here’s some more color.

The joint moves in the VIX and stocks come just a few days after a big investor bet on the VIX caused tremors in the options market.

One trader on Thursday bought 20,000 July VIX calls at the 45 strike and sold 55 strike calls for an overall premium of 42.5 cents in a trade that cost about $850,000 to execute. The net impact is that the VIX would have to beat the 45.42 level by the July expiration for the investor to make money. The VIX hasn’t been past 40 since April 21.

“The last few weeks we’ve come under 30 and we’ve been under 30 as investors became more sanguine in their approach,” said Andrew Wilkinson, senior strategist at Interactive Brokers. “This was a standout trade that went against the grain.”

While there would be no direct correlation between such a huge trade and the actual VIX movement, the bet could be indicative of a shifting mood.

Let me get this straight, for $850,000 of cheap VIX spread caused tremors in the options marts? The spread has a delta of about 8 now, after the lift. Meaning someone hedging the other side only has to buy about 1 VIX future for every 12 spreads he does. Which would have modest upside impact on the future, but really not cosmic. Especially since as a vertical, it’s defined risk, and will likely be underhedged.

Could this be indicative of a shifting mood?

It could. It could also someone hedging a portfolio that has had a nice run. It could be someone taking a cheap VIX shot. It could be a desk with Variance risk just closing something off. It could be Lenny doubling down.

What it can’t be is all that meaningful. There are countless trades of this size each and every day all across the floors. If someone can move entire markets by purchasing $850,000 cheap OTM VIX spreads, we have bigger issues to deal with than we realize.