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.