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The big bet against market volatility

As the volatility index hit its lowest level of the year this week, one trader placed a large bet that stocks will continue to rally.

The CBOE volatility index, also known as the VIX, measures investor uncertainty based on the price of S&P 500 options. Put options can be used as a hedge against downside risk, so the higher the price, the more investors are willing to pay for that protection.

On Monday, one trader bought 13,000 of the VIX June 15-strike put options for 20 cents each. This is a $260,000 bet that the VIX will fall below 15 by June expiration (since VIX options have a $100 multiplier).

Read MoreDon't panic about market volatility: Jack Bogle

A fall to 15 would be a 24 percent drop from where the index traded on Tuesday.

"[This] is a long way down, even from the levels we've seen it decline to today," Mike Khouw of Optimize Advisors said Monday on CNBC's "Fast Money." "For the VIX to get to that level, the S&P would need to rally quite significantly. ... At least one person is betting that this rally could continue."

Khouw said for the VIX to fall to 15, the S&P 500 should rise at least to 2,050. On Tuesday morning, stocks reversed gains for the week, with the S&P 500 falling to 1,927 by late morning.

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