VIX Spread Trade Still Has The Pit Buzzing
By Russell Rhoads, CFA
Things are fairly quiet today in the equity markets and the VIX
pit, but traders are still talking about a pretty interesting
spread
that was initiated on Tuesday. A trader came in and sold 25,000 VIX Sep
17 Calls and subsequently purchased
200,000 VIX Sep 27 Calls for a net
cost of 0.02 (two cents to clarify the decimal was not misplaced) or in
real dollar
terms a cost of $50,000. In textbook terms this is a 1 by 8
Call Backspread. It trader terms this is a, “I expect (or hope)
VIX
runs to the 30’s between now and September 18th” which is
expiration date for VIX futures and options. The payoff
diagram shows
why VIX in the 30’s would be a good outcome for this spread trade.
VIX is just a bit under 16.00 today which at expiration would result
in both legs of this spread expiring with no value and
the trader being
out the premium paid for the trade. A worst case scenario for this
trade involves VIX rallying but only
to 27.00 at expiration. This worst
possible outcome would result in a loss of $25,050,000. That’s because
the short
position in 25,000 of the VIX Sep 17 Calls would be 10 points
in the money. In math terms it is $10.00 x 100 x 25,000
or $25,000,000
plus the $50,000 cost of initiating the trade. The breakeven point is a
fraction of a cent over 28.43.
Above this level the trade makes
$175,000 for each 0.01 VIX move to the upside. Odds are this trade
would not make
it to expiration in the case of a rally, but we will have
to wait and see over the next couple of weeks.
