At the worst point last week the S&P 500 was down 9.5% from the closing high of 2011.36 on September 18th and down about 4.5% from last Friday’s close. By Friday we came back to less frightening levels and closed the week down 6.2% from the all time closing high and down 1% on the week. For those that count a correction as a 10% move, we didn’t have one. The guys in the SPX and VIX pit may have a different opinion of how the price action felt. All kinds of volume records were tested or beaten and VIX climbed to levels not experienced since December 2011.
The left side of the term structure VIX curve is in backwardation and the right side looks a little more ‘normal’ in contango. Of great interest is the October VIX contract which settled at 21.00 while the cash index finished the week at 21.99. There are two more trading days remaining for October volatility oriented futures and options so that spread should narrow quickly as time passes. The question is does the index move higher or the futures more lower.
I’m always on the lookout for sellers of volatility when VIX is having a headline grabbing day. One trade I saw on Thursday morning, but before we started to see lower levels for VIX and the October VIX futures was a big seller of VIX Oct 19 Calls at about 4.50. As the payout diagram below shows – VIX settlement under 23.50 will result in a partial profit and if the S&P 500 follows through this week and pushes VIX back down into the teens a full profit of 4.50 could be realized. However, I would be remiss if I did not point out the right side of the payoff diagram below. VIX climbed to 31.06 last week and a resumption of a stock market sell-off may result in VIX returning to much higher levels. I intentionally have the loss line going to 35.00 just to show that short volatility that does not have any sort of hedge against a big spike is a pretty risky and scary prospect.