The VIX jumped 34 percent on Monday, leading to an obvious question: Why did investors rush out to buy insurance on a day that began with so much promise?
Since day two of 2013, we have seen the S&P 500 rise and the VIX rise as well, something not seen for this lengthy a period of time since 2007, when the housing market began to crack.
Typically, these two trading vehicles move opposite to one another, with the VIX rising faster when markets fall, and falling slower when markets rise. So now, we need to dissect what might be causing so much upward pressure on the VIX while the stock market remains so elevated on the year.
Well, two theories come to mind. First, with bond yields so low historically, and gold underperforming, investors searching for risk-off holdings are increasingly turning to volatility.
Thus, any credit market risk that has the potential to spook the market—even if it doesn't cause as sell-off—has caused VIX to jump. Case in point: As Italian yields rose Wednesday, investors rushed to buy volatility and insurance on their portfolios. Such panic buying of portfolio insurance should, and did, cause a flush-out and carpet shake of the markets that pushed S&P higher once everyone had overpaid for protection.
As Bernanke spoke to Congress Wednesday, the VIX came off its highs very hard. Typically, I like seeing the VIX come down hard in the short-term, because it means investors view the risk to the overall market as being over. The VIX moves up and down, I find, confirms that all we saw was a carpet shake in the market's bull run.
That was the first theory. But my second theory puts things in a more apocalyptic light. If VIX is rising and the market is rising, like it did in 2007, are we experiencing an unraveling in the credit markets somewhere in the world, such as in Europe, that the average retail investors has not caught on to?
We did see one institutional investor look to buy 10,000 May $20 calls, and sell May $25 calls, by paying $0.24. Meanwhile another trader bought 5,000 March 17/23 call spreads for $0.56 each. Thus, even as the smoke has cleared—likely for the next month at least—investors intraday are starting to look for hedging strategies in case something ugly comes up down the road.
Strategies like these tend to pay off very well. With the VIX moving so hard, you don't really need a lot of volatility protection. However, in case my second theory comes to fruition, stay long stocks, but keep buying insurance in case a bad storm hits.
Disclosures: Stutland is long bull VIX futures and options spreads. Stutland is a market marker holding hedged positions in VIX futures and options.
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."