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Cyprus and What It Means for the VIX

Central Bank of Cyprus
Chris Ratcliffe | Bloomberg | Getty Images
Central Bank of Cyprus

The VIX surged about 20 percent Monday on the open of U.S. markets. Clearly, the news of Cyprus's proposed bank deposit tax is leading to expectations that volatility will return to the market.

Not only is the VIX trading around the 13 level, but April and May VIX futures are trading at premiums of a couple points, compared to the spot price.

(Read More: Cyprus Bank Tax Lit 'Two Sticks of Dynamite': El-Erian)

Investors trading the credit markets will typically follow VIX price movements because as issues arise in the credit of the banking system, there is less money to go around and enter into the stock market. Less money in the stock market means more daily swings in the market.

Up until Monday, liquidity has been pouring into the system, with equity mutual fund inflows continuing to expand. Lipper reports that over the last four weeks, equity fund inflows stand at just under $21 billion. These inflows into the equity market have counterbalanced banking problems in Europe, helping to maintain order in the markets.

The stabilization that has been occurring in the markets up until Monday was echoed in the VIX pits on the open. One trader sold 10,000 March 18 puts while purchasing 20,000 March 16 puts, for a net debit of $0.55. Because the trader bought extra March 16 puts, we can tell that he or she is betting that the VIX closes below 13.45 by this Wednesday's settlement date.

(Read More: Cyprus Revising Plan, Banks Stay Shut: Reports)

Ever since the trade went up, the VIX headed straight down, indicating that any volatility pop is being sold, stock markets are being bought, and all is well in the world.

Certainly, the new policy in Europe could create runs on banks in Europe, if it were to be implemented throughout the region for any unstable bank. However, you have to ask yourself whether that will actually unravel the global economy.

I am not so certain that anything changes since money will go somewhere, and not under the pillow. What might cause some worry is how the banks will operate. If nothing else, the message to banks might be that though should be very, very conservative in their investments!

Yet while European banks might need to be more risk-off in order to maintain balance and confidence with their depositors, I believe that will present an opportunity for others to scoop up that risk.

Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."

Disclosure: Stutland is a market maker holding hedged positions in VIX. He also owns some bull VIX futures and options spreads in his personal account.

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