VIX Spread Trade Still Has The Pit Buzzing

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 1 x 8

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.

  • everybodyknows

    Wow! Somebody has got $50k they don’t need- riskier than Vegas.

  • harfangcap

    the time premium that the trade will be MTM during any spike combined with other positions the trader/fund/bank undoubtedly has, confuse the nature of the bet and your diagram especially does so.

    • Russell Rhoads

      I totally agree and would not be surprised if there are many other positions combined with this single trade. I just wanted to isolate this trade and demonstrate a unique payout that can be created using VIX options.

      • harfangcap

        Yeah, it is an interesting trade, thanks for finding.

        • Russell Rhoads

          Thanks for commenting! Sometimes it’s hard to figure out what people find interesting, I think this one hit the mark!

  • happel

    I’ll bet 50 cents if this pans out, we will find out after the fact that the Vampire Squid is somehow benefiting from this trade.

  • Chinmay Patil

    Why is everybody only looking at the premium. Look at possible loss if VIX misses the mark (30+) by a few points???

    • Russell Rhoads

      I tried to highlight that by pointing out the max risk if VIX is around 27.00. I do doubt that the trade would not be managed a bit with other positions if VIX begins to rally.

      • Chinmay Patil

        I meant people in comments..
        Ratio Backspreads are very deceptive (especially when one zooms out and look at the long leg’s profit potential..

        • Russell Rhoads

          I figured it was on the comments, I just wish I had emphasized it a bit more so people got the true risk / reward.

  • dan

    The other interesting thing is the “crowd” is now theoretically short size tails. If something does give this could get hairy….

    • Russell Rhoads

      That’s a great thought – be aware the market makers (crowd) will hedge themselves in futures to lay off some if not all of the risk.

  • robertw477

    It is amazing. I don’t have great knowledge about these VIX options myself. I would not have the sheer guts to put this on. With my luck the trade would score big a few days after expiration

  • http://chartianity.wordpress.com/ Vconomics

    Why can’t I locate this trade? Here’s a snapshot of every trade (over 1000) for the VIX Sept-18 27 calls on September 3rd. There’s a 100,000 purchase but no 200,000 purchase.

    • Russell Rhoads

      When the trade is done open outcry it is going to be put on the tape in pieces based on the number of traders that took the other side of the trade.

  • http://www.wallstreetboy.com/ Lawrence Lugar

    “How $50,000 bet on VIX spike could pay $27 million in two weeks” -MarketWatch

    …What’s the percentage probability…that this 50K trade will turn into 27 million?
    Must not be that high, if the rewards are that substantial…

    • Russell Rhoads

      It is possible, but VIX would need to be at levels not seen in almost two years and get there in just a couple of weeks. You can place the odds on that based on the VIX action this year (pretty low based on near term history). Most likely this is part of some sort of hedging program that is looking to guard against an outlier market move and not necessarily a speculative trader.

    • g13man

      Do we know that this is his way of keeping volitility down for his other trades ? might be a diversionary ploy ! After all he can lose alot [million[ if it miss the mark…so he/they have something else going on for sure , Like a magician , drawing ur attention the wrong way for the porformance of a life time .

  • techy net

    so if vix goes to 27, this trade loses 25 million. But on the upside profit keeps going up. Kind of makes you think if somebody is expecting something really bad happening.

  • → Trader618.com

    >>> Investors Be Careful <<<

    DOW monthly chart as of June 2013 shows brutal Wile E Coyote megaphone wedge.

    Chart here: trader618.com