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A Gutsy Bet That the Market Has Bottomed

Tuesday's sell-off in equities sent many scrambling to buy downside portfolio protection. One big trader, however, did just the opposite.

A Gutsy Bet That the Market Has Bottomed
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With the CBOE Volatility Index at 18.95, one trader sold 32,000 VIX Nov. 19-strike calls for $1.95 each.

So what is this trader predicting?

This is a bet that the VIX — a measure of the volatility that investors expect to see in the S&P 500 — stays below 20.95. It also implies that the trader expects the S&P 500 to fall, at most, only a few more percentage points before bouncing back.

How is this? Well, historically, the VIX has moved up 4 percent for every 1 percent move down in the S&P 500. By that logic, this trade will be profitable if the S&P 500 ETF remains above $135.70 through November expiration.

Although the call sold in this trade is 16 percent out of the money, it is still a very risky sale. A short call has unlimited upside risk, and it is not uncommon for the VIX to make sharp moves upward. That is why I would prefer to keep my risk fixed and defined by buying a further-out-of-the-money call when making these types of trades.

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

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