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.
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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