Late yesterday an interesting spread trade that hit the VIX Option pit here at CBOE was pointed out to me. The one liner in trader speak was –
VIX paper bot 32,000 nov—oct 26 c/sprd —- bot 32,000 jan –feb 26 c/sprd pd .05 on the 4-way
So what the heck does that mean in English?
A spread order in VIX Call options focusing on the 26 strike price option contracts across four different expiration dates was executed for a net cost of 0.05. The individual legs of the trade were –
Selling 32,000 VIX Oct 26 Calls
Buying 32,000 VIX Nov 26 Calls
Buying 32,000 VIX Jan 26 Calls
Selling 32,000 VIX Feb 26 Calls
There are some interesting scenarios where this trade works out for the buyer. Looking ahead, it appears the best case would involve some sort of move higher for VIX occurring after October expiration (October 17th) and before January expiration (January 16th). During this October to January time period the spread will hold twice as many VIX calls as it is short as the short leg in Oct calls will have expired.
As we further dissect this big trade, it may also work out if VIX were to run up quickly before October expiration but have October settlement come in under 26. There is a lot of room for error with VIX currently under 17. This trade might also work based on the reaction of VIX futures to a move in VIX. Remember, VIX option valuations are best determined using the corresponding futures prices as the underlying. A curve that has October and November futures trading close in price and January at a significant premium to February may have a positive result as well. These are just a couple of many potential scenarios that might work out for the buyer of this spread.
The risk that I see with this trade is VIX climbing quickly and October moving up to a significant premium relative to the other contracts. In this case the premium for the near dated Oct 26 Calls could rise more than the premiums for the Nov and Jan 26 Calls. This sort of outcome is why on the surface it looks like this trade anticipates a move in volatility that may occur after October expiration.
We could spend all day trying to determine the best and worst possible outcomes along with the motivation behind this interesting spread using VIX options. This just shows the flexibility of VIX options along with the unique sort of outlooks that may be anticipated and capitalized on through trading VIX options. I’ll keep my eye out for any 32,000 lot trades in these four options. If it appears there is an adjustment to the trade, we’ll try to get into the mind of the trader again to figure out the motivation behind the change.