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Najarian: Options trader makes big bet on a rapid market drop in the next week

The iPath S&P 500 VIX Short-Term Futures ETN (VXX) is an exchange traded note that was constructed to provide investors exposure to the CBOE's VIX index, which is also known as "the fear index."

This is because the VIX and corresponding VIX futures reflect the demand for protection in options on the S&P 500. That demand for protection manifests itself in higher prices for both VIX and VIX futures. For this reason, the VIX is known as an inversely correlated index, moving up when the S&P 500 moves down, and moving down when the S&P 500 moves higher.

Thus, when there's a large trade in VIX options or futures, it expresses either the fear or confidence of a sophisticated investment manager and can foretell future movements in the markets.

Today, our HeatSeeker algorithm picked up on a large trade in the VXX calls, as 30,000 of the May 18 calls were bought for $1.53, and 30,000 of the September 24 calls were sold for $1.55 with that ETN trading at $17.72.

This trade is known as a diagonal, as the expiration of the options contracts are in separate months. The size (30,000 contracts) means the trader controls 3,000,000 share equivalent of the VXX between $18 and $24, and thus could turn a volatility burst into millions of dollars in profit. Conversely, if nothing happens and or the VXX drops over the next week, the long May calls will decay far more rapidly than the September calls, which could result in some painful losses.

You would do a trade like this if you wanted protection in the short-term against a big surge in volatility over the next couple weeks. Potential catalysts include North Korea, Syria, Russia or Thursday's use of the "mother of all bombs."

What we know about these volatility pops is that the shelf life is getting shorter and shorter. Volatility barely held one full session after Brexit and it held less than 12 hours after the Trump victory.

So be aware of what the player establishing this trade is no doubt cognizant of, and that's that a surge in VIX would likely be met with extremely aggressive selling in just hours. I share this to make sure any of you that have not previously traded these volatility contracts don't think of them as traditional investments. These are trades, and/or quick hedges, not investment vehicles.

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