The million-dollar bet that markets will get rocky
Either the markets are about to get rocky, or one major trader is about to lose $184 million.
On Monday, the CBOE Volatility Index (better known as the VIX) almost instantly popped 10 percent off the opening print, even as things seemed relatively calm in the market. After all, the Chinese overnight data seemed OK, and Apple, a big component of the Nasdaq 100, was off to a roaring start.
However, it seems that a big institutional fund in the marketplace is getting worried. The trade consequently entered by this institution was sizable enough to force market makers to tick up their volatility expectations, and it has me concerned that these markets could get a little shaky through the end of the year.
(Read more: 'Uptrend is intact' for S&P 500: Yamada)
After the market opened, a trader purchased 20,000 S&P 500 December 1,700-strike straddles for $92.00 each. What is a straddle, you ask? Well, the trader bought both the 1,700-strike calls and the 1,700-strike puts at the same time. That means that if the index moves higher, the trader will win on the calls, and if it moves lower, then they will win on the puts they own.
But a win-win situation such as this comes at a price, and this trader was willing to pay a whopping $92 in premium for the luxury. Thus, the trader needs to see the S&P 500 index close either below 1,608 or above 1,792 by December expiration just to break even on the bet. That means this trader has paid $184 million in premium for a trade that could go out worthless if the S&P does not move away from the 1,700 level.
And there's something else at play here, too. In addition to betting that the S&P will see a big move, this trader is also betting that volatility will increase, and options will get more expensive.
When people start betting on higher volatility, that makes me concerned that the S&P 500 index is getting a little toppy. And in fact, when I saw this trade Monday morning, I, too, raised my exposure to volatility. However, I tried to do it in a way that lowers my cost—because S&P 500 options are now worth some 10 percent more than they were on Friday.
Disclosures: Stutland's firm is a market maker holding hedged positions in VIX futures and options. Stutland personally holds a bullish futures position on the VIX.