VOLATILITY RULES

We would like to welcome a new contributor to the CBOE Option Hub. Henry Schwartz.

Henry Schwartz is the president of Trade Alert LLC, a provider of real-time options analysis tools to leading Wall Street firms. His systems analyze hundreds of thousands of transactions per second to help professionals identify and interpret market activity in real time, supporting informed trading decisions and intelligent idea generation.

He has held institutional trading and management roles with Bank of America, Bear Stearns, Salomon Brothers and the Hull Group, and made markets on the CBOE and AMEX floors in the US, and EUREX and MONEP overseas. Prior to founding Trade Alert, he led the electronic market-making group at Bank of America.  He holds a graduate degree from NYU’s Stern School of Business and a bachelor’s degree in Economics from the University of California, San Diego.

You may have seen some of Henry’s insightful  comments in The Striking Price in BARRON’s or in other articles.  We are big fans of his work and hope you enjoy his articles in the Hub.

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What a week for volatility products!

On Tuesday the CBOE VIX index options set an all-time volume record near 1.8million contacts, and the following day it was another volatility-based product that took the spotlight; the VXX iPath Short-term VIX ETN. More than 1.34 million VXX options traded on Wednesday with puts leading calls 4:1, and 75% of the put volume spanning four November contracts. Trade of the day was a 4-legged put ‘ladder’ spread in which a trader bought  5 Nov 16 puts and sold 4 each of the Nov 15 and 14 puts, and 6 of the 13 puts for a small net debit.  The initial size was massive- about 88,000 of the 16 strike puts bought vs a sale 70K each of the 15s and 14s, and 106K of the 13s.  Several later tranches nearly tripled the initial trade size.  Most of the action took place an hour into the day when sentiment about Washington was at its darkest and the broad market near lows while  VIX spot was over 21 and VXX was above 17.  CBOE saw 70% marketshare and this morning’s open interest data shows a net increase of 430,000 puts- or just below half of what traded.

Directionally, one way to think of this trade is a long put at the 16 strike, with the lower-strike premium sales added to paying for the position. The trader is most definitely looking for VXX to decline- with maximum gains coming if the 16 strike put is in the money-  but this structure would become a massive loser if VXX were to trade toward (or below) the low strikes.  If VXX climbs, the trader would lose only their debit- in this case about $200K from the first tranche.  The fact that VXX value is based on VIX futures is important to keep in mind, since a broad market rally normally sends VIX products lower.

Henry VXX

While CBOE VIX is normally the product of choice for institutional sized blocks such as this, it’s interesting to see the often maligned VXX ETN catch fire.  VXX has been forced to reverse split twice over the years- as the contango in the underlying VIX futures became a consistent drag.  The recent near-term volatility reversed (or at least reduced) the this drag, and the force behind this big block may have been waiting for just this moment.  With headlines this morning suggesting negotiations may be moving forward in Washington, the VIX term structure has flipped back to contango and VXX is back to 15.45 and my calculations show the trade is up about 58% in value.