Big Trader Bets on a Fear Surge
The VIX dropped dramatically Wednesday morning, as fears over Cyprus's financial crisis dissipated. A lower VIX means that the cost of protection, or portfolio insurance, has gone down—and that spurred one option trader to buy some.
(Read More: Market Hits New High Despite Cyprus Standoff)
So far, the biggest trade of the day in the VIX has been the purchase of 116,000 April 17/27 call spreads for $0.70, which was done with the April VIX future at 14.80, and the spot index at 12.90.
This trade will work as a portfolio hedge if the market sells off enough to push the VIX above 17. If the VIX goes all the way above 27, which is 110 percent higher, then the gain on this trade is capped to $10. Therefore this hedge will offer ample protection during a 5-10 percent market correction, but is not designed to hedge a truly panicked VIX move, like we saw during the debt downgrade or in 2008.
The March VIX future expired Wednesday morning, so this trade could be a re-ignition of an expired hedge from March, or it could be a timed trade based on the Wednesday's downtick in the VIX.
In any event, implied volatility in the VIX has come down about 2.5 points on Wednesday, which makes buying out-of-the-money options less costly today than it was earlier this week.
—Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."
Disclosures: Stutland is a market maker holding hedged positions in VIX. He also owns some bull VIX futures and options spreads in his personal account.