Options traders bet on even more volatility flooding the market

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One options trader bets market volatility just getting started

The Dow just posted its worst day of 2019, plunging 800 points as the U.S. yield curve inverted, sending recession signals surging through the broader markets.

But Wednesday's plunge didn't just come out of nowhere. The index shot nearly 400 points higher on Tuesday following a decline of nearly 400 points on Monday. Plus, we're just 10 days removed from a 767-point drop.

So, when the market is in the grips of a roller-coaster ride and worrisome headlines keep swirling, what can you bet on? In a volatile market, the answer is: bet on volatility.

As Michael Khouw, president of Optimize Advisors, pointed out Wednesday's "Fast Money," nearly twice as many options contracts traded hands than the 50-day moving average, and many of those were in the volatility index.

"Where we saw a very interesting trade, and many of them, actually, was in the VIX index," said Khouw. "Specifically, I was looking at the 30/35 call spreads. Somebody paid a little over 30 cents for 26,700 of those call spreads, which could potentially be worth $5 [per contract]."

Those contracts expire Sept. 18, and are expected to appreciate in value as that date gets closer, thanks to the options market pricing in more and more volatility entering the market environment. The volatility index closed Wednesday at 22.10. So, does this trader really expect the index to surge all the way to the mid-30s in just about a month?

Not exactly, as Khouw explained.

"I think the important thing to think about here is, it's not just that someone is betting that the VIX could go above 30, because the underlying instrument for these options is the VIX future.

"What happens is, when you see a lot of volatility the VIX curve actually ends up in backwardation. Spot VIX will end up even higher [than the futures]," Khouw said. "So, a bet that that future rises above 30 is a bet that something pretty wild is going on in the marketplace."

Will VIX futures climb above 30? It's tough to predict. However, with a few more days of wild swings in the market, they could move higher very quickly. The more likely scenario is that this trader is looking for the VIX to climb into the mid-20s over the next week of trading so they can sell these contracts at a profit.

The VIX was down Thursday, while VIX futures were slightly higher.

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