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Over the past six months, the CBOE Volatility Index (VIX) has averaged a reading of 11.58 — lower than its one-year mean of 12.63, and considerably further south than its two-year average of 15.37. The most cursory review of a daily price chart for 2017 clearly displays the VIX’s “typical” trading range ratcheting down to the 9.50-12 area during the second quarter, compared to 10.50-13.50 for much of the first quarter.
And while last Thursday brought us another one of those occasional spikes up to the 15-16 region — which have been the sole and infrequent interruptions to this year’s generally soporific VIX trend — the “fear index” cooled all the way off to 11.44 by the close that day, and finished the first half of 2017 down about 20% from its year-end 2016 close.
Given the endless parade of headlines touting the many and varied risks to this market — whether macroenomic, geopolitical, or otherwise — quite a few analysts (present company included) have spent a healthy (or, depending upon your perspective, unhealthy) portion of 2017 reading the proverbial tea leaves to discern when the seemingly inevitable VIX spike will take place. So far, with a full 50% of the calendar year in the books, we have yet to see anything approaching a lasting breakout, an uptrend — or even a new 52-week high, however brief.
But this past week, a VIX options indicator tracked by our Quantitative Analyst Chris Prybal reached a multi-year extreme that suggests traders’ anticipation for that elusive VIX pop is approaching fever pitch. The 20-day buy-to-open call/put volume ratio for VIX options jumped to 6.63 on Tuesday, marking the indicator’s highest level since July 2, 2007 (with our full data set on this metric dating back to January of that same year). While it’s admittedly a look at only one dimension of VIX option activity, this call/put ratio extreme tells us that traders are opting for bullish volatility bets over bearish by the widest margin in the last decade.
Worth calling out specifically is the action that took place last Tuesday at the VIX July 25 call, where 90,250 contracts were bough to open, according to data from the Chicago Board Options Exchange (CBOE) — with much of the action here paired with sold-to-open July 30 calls, as the trader created a vertical spread on volatility. VIX hasn’t printed above 25 in just over a year, with the index’s last foray above this area prompted by the June 2016 Brexit vote; further, the VIX Options Settlement Index (VRO) last settled above 25 in January 2016.
When they purchase VIX calls, we can surmise that traders are most likely either (a) speculating on a volatility ramp; or (b) hedging their short volatility positions. In favor of scenario (b) is the near-record net short position in VIX futures among the “large speculators” group, as defined in the weekly Commitments of Traders (CoT) data. Notably, this group would have had an added incentive to replace their VIX call hedges over the past week and a half, following the recent expiration of the June options series. And if reports about the identity of the suddenly notorious “50 Cent” buyer of VIX calls can be believed, at least one investment firm has been very conspicuously hedging against a VIX eruption.
VIX spikes tend to do the most “damage” when they occur unexpectedly, and when those who hold sizable short volatility bets are not properly hedged against an adverse move. So in that respect, contrarian stock market bulls might be heartened by the voracious call buying on VIX — but they should also hope fervently that those who are short VIX futures are not implementing vertical call spreads like the one described above as their hedge against a VIX pop. With that sold VIX call at the 30 strike comes a distinct lack of “worst-case scenario” protection, which would make this a very strangely complacent (and potentially disastrous) kind of “hedge.”
Subscribers to Bernie Schaeffer’s Chart of the Week received this commentary on Sunday, July 2.