Rather than reaching for the Dramamine, many options market speculators are seeing opportunity in increased stock market volatility through purchasing call options tied to the Volatility index.
The Chicago Board Options Exchange Volatility index, which has advanced from closing readings as low as 9.9 last December to present levels approaching 18, has rewarded call options speculators who have ridden the rising VIX wave.
The volatility index is calculated using a wide variety of implied volatilities from S&P 500 index options and is designed to show expectations for 30-day volatility. It typically rises when the market falls, or when the investors are worried that markets could move lower. The VIX generally falls in tandem with rises in the stock market, or when potential dangers abate.
"When there’s an expectation for a market decline, there's a rise in implied volatility on VIX itself and for the options on the VIX," said Scott Fullman, director of investment strategy at I.A. Englander. "You’re seeing speculation that the market is going to become more volatile. That is implying that there are people out there who are trying to use the VIX to (outperform the market) should the market have a significant decline."
Fullman says investors are paying up for the chance to make money off a more volatile market. "The August 18 VIX calls right now are quoted $1.10 to $1.25, yet the theoretical value is 68 cents. We’re seeing a very high premium to me -- I think that these things are very, very pricey."
Open interest in July VIX calls overwhelms open interest in puts by a margin of more than 6 to 1. High call open interest in VIX options has translated into an overall (including months beyond July) put-to-call ratio of just above 0.4 -- providing another indication that investors have largely been betting on a further rise in the VIX.
It's not a complete surprise that volatilities have surged in options of student loan firm SLM, commonly known as Sallie Mae. The private equity firms J.C. Flowers and Friedman Fleischer & Lowe, as well as JPMorgan Chase and Bank of America, which agreed to acquire SLM, warned that current legislative proposals before the U.S. House of Representatives and U.S. Senate "could result in a failure of the conditions to the closing of the merger to be satisfied." The news sent SLM plunging .
Not only have call options tumbled, including an 87% drop for SLM July 55 calls, but implied volatilities have surged to 50, nearly three times higher than normal. Speculators who feel the deal might be doomed have reached down to the purchase July put options as low as the 40 strike, more than $10 below the present level of the stock.