The fear is back.
After a brutal Thursday session, S&P futures and VIX futures both pointed the way toward another tough day for the markets in early Friday trading ahead of the jobs report. And that must be welcome news for one major options player, who made a multimillion-dollar bet that the surge in volatility will continue.
On Thursday, the lost 2 percent the CBOE Volatility Index (or the VIX) surged 27 percent to close at the highest level since mid-April. And in a big bet that there's more volatility to come, one trader bought 90,000 November 21/30 call spreads for about 70 cents each, in a $6 million trade that will only make money if the VIX continues to rise into the fall.
The VIX is known as the market's fear gauge, because it tends to rise as investors make options bets that the S&P 500 is vulnerable to a drop. That's also why the VIX tends to rise as stocks fall.
And in a huge Thursday trade, one trader bought Nov. 21-strike calls for $1.15 and sold Nov. 30-strike calls for 45 cents. This cost a little more than $6 million in total, and will only pay off if the VIX gets to 21.70 by Thanksgiving. However, if the VIX goes much higher, then this trade will be massively profitable. If the VIX is at 30 or above at November expiration, this trade will net $75 million.
"People are looking to buy some cheap protection when everything's getting expensive in terms of insurance now," commented Brian Stutland, an options trader and the developer of the Equity Armor product, which combines S&P exposure with volatility exposure.
On Thursday, even the defensive utilities sector fell hard, and traditional safe haven assets like gold and Treasurys slid along with stocks. That made the VIX one of the few places where investors could actually find an effective hedge.
Dan Nathan of RiskReversal.com points out that the level where this VIX trade breaks even, 22, is just about where the VIX topped out in December 2012, June 2013, October 2013 and February 2014. But given that the VIX has stayed so low for so long, a continued VIX surge at this point would be none too surprising, he says.
Interestingly, the trade—which was executed from 10:00 a.m. EDT to 10:20–already looked good by the end of the day, because the VIX continued to rise throughout Thursday's session. In fact, the spread was worth about 5 cents more by Thursday's close, for an intraday paper profit of 7 percent.
—By CNBC's Alex Rosenberg
Follow the show on Twitter: @CNBCOptions.
