Options traders sense a glimmer of hope in the market

A tumultuous start to 2016 sent volatility surging this week.

The CBOE volatility index spiked above 20 for the first time since mid-December, as U.S. equities saw their worst start to a year since 2008. Despite the burst in volatility, some options traders are betting that better days could be ahead.

On CNBC's "Fast Money" Wednesday, Mike Khouw noted that as global equities have tumbled this week, there's been an abundance of put activity in the VIX. "When you are making bearish bets on the VIX, then you are making bullish bets on the S&P 500," said Khouw. The S&P 500, which is inversely correlated with the VIX, is trading at its lowest level since October 2015.

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Much of the activity seen on Wednesday was in the January 20 weekly 16-strike put options, with more than 44,000 being bought at an average price of 10 cents. These trades indicate that the VIX could fall dramatically over the next 10 trading sessions.

"We're in a little bit of a dangerous area here," warned Khouw. "Typically, when the VIX is below 15 it's a good time to buy stocks. When the VIX is over 25 that indicates that the market is oversold and that could be a good time to buy stocks," added the Optimize Advisors co-founder. "Interestingly, though, when you buy it between 20 and 25, you see below average returns in the next 30 days, so this is a bit of a counterintuitive trade."

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For those looking to buy protection from further losses, Khouw recommended two simple strategies: selling a call against a current position, or using a spread to mitigate high options premium. "You could buy a spread in the S&P 500, using the SPY [the S&P 500 ETF] as a proxy," said Khouw.

The S&P 500 was down nearly 1 percent early Thursday.

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Host Bio

  • Melissa Lee

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

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