VIX at 50?! Options Boil on Volatility

Crazy bets on market volatility and a big move in Morgan Stanley ... That's what the options market seems to be looking for, according to Rebecca Darst of Interactive Brokers.

The real attention-getter, Darst said, was a single huge bet that market volatility, as measured by the VIX index, would blast up to 50. At its Wednesday close it was around 36. The higher the VIX, an index of option hedging activity, the more nervous the market.

"We actually did see somebody enter a large-size long position in November 50 calls. On the VIX , November 50 calls," she said Thursday morning on CNBC. "It was 15,000 lot transaction. There was not terribly much open interest at the strike, so we can safely conclude that this was an opening purchase. (There is) about a 5 percent chance, according to current market conditions, that VIX will break 50 by November, so we'll see what happens. We've been stuck in a bit of a regime for several months where these incursions, up about the 50 line, have been very short lived."

That bet was part of an overall boil in the options market around future volatility, she pointed out.

"Forty-two percent of the action on VIX options yesterday was in October calls between 30 and 35, and there was heavy buying interest here, so clearly there were a lot of option traders very nervous. We saw some isolated spreads in October, people sort of positioning in favor of perhaps a return to the way things have been, so I think, you know, it's a different set of circumstances we've got here. I think people don't quite know what the endgame is."

At the same time, options traders think Morgan Stanley stock is going to make a big move. They just don't know which way, Darst said.

"Basically, the options market is pricing-in a huge potential move in Morgan Stanley," she said. "Implied volatility in Morgan Stanley up another 51 percent yesterday. The front-month options options are calling for, if you take the front month at the money straddle, which expires on Friday, as a guide, option traders are pricing-in for as much as a one-third price move to the upside or the downside between now and Friday. That could be a recovery if there's some sort of deal struck that the market approves of, there could be a downside if current momentum continues."

"Obviously, in these brokerages (like Goldman Sachs and Lehman), if you look at the options, very, very large volumes going in deep out-of-the-money puts to buyers and sellers, so there's a real revolving door of traffic going on here, and I would expect that with volatility at these levels a lot of traders are resorting to spreads to limit their risk, limit their initial cash outlay with the VIX at these levels and with implied volatility so high on a lot of these financials," she said.