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How traders are looking to profit off of market fear

The spike in fear has a few traders looking to reap tremendous profits.

Since the CBOE Volatility Index, the VIX, tends to rally when investors feel worry it's often called the "fear index." But some are using that spike in fear as an opportunity to sell options.

Monday's selloff in stocks caused the VIX to rally 7 percent despite only modest losses in the S&P 500. That rally sparked a flurry of call activity, where volume ran 1.5 times its daily average. One notable trade was the sale of 56,000 of the June 18-strike calls for 41 cents each. Since each options contract size is for $100 times the VIX, the trader took in $2.3 million in a wager that the VIX will be below 18 by next Wednesday.

When traders sell calls, they are betting that the underlying security will stay below the strike of the call option that they sold.

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders work on the floor of the New York Stock Exchange.

"Now that we've seen the market off 2.5 percent or so from its highs, we saw some traders take profits and harvest their gains in volatility," said VIX trader Brian Stutland, founder of Equity Armor Investments. "Now that we've gotten a selloff, they've taken some profits."

Nonetheless, the VIX is nowhere near its January highs in the low 20s or its 52-week high of 31.06 when the market had a major selloff in mid-October. The VIX was down 3.2 percent to 14.80 midafternoon Tuesday.

But Stutland sees Monday's drop in stocks as a chance to make a quick gain in the VIX before the market makes a short-term rebound.

"I suspect the S&P 500 trades back to 2,100 before going ultimately lower," he predicted. The S&P was down slightly Tuesday afternoon.

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  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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