Options Update: Put Volume Spikes on CBOE Market Volatility Index (VIX)
A Lesson in Volatility
Looking at today’s Intraday Volume Explosion List, it seems that last week’s trend toward higher put volume has spilled over into today’s trading. But before we dive too deep into today’s activity, let’s take a closer look at the VIX itself.
Historically, the VIX has been an excellent barometer for the relative level of premiums that options traders have had to pay. The index gauges expected market volatility over the next 30 calendar days by calculating a weighted average of S&P 500 Index (SPX) options with a constant maturity of 30 days to expiration. Extreme high and low VIX readings can provide good contrarian signals, though it actually doesn’t matter where the reading lies on an absolute basis if it is at an extreme relative to its recent readings. Buy signals often occur as the VIX reverses lower after an extreme peak, while sell signals occur as the VIX moves higher off an extreme bottom.
Bringing the rhetoric down a notch, a rising VIX indicates higher option premiums as market makers price in higher volatility in the overall market – typical of periods of market decline. Meanwhile, a falling VIX indicates lower option premiums due to lower expected market volatility – typical of periods of market stabilization or uptrends. With that in mind, today’s heavy put volume on the VIX could imply that these options traders are looking for volatility to stabilize, and the overall market to potentially extend its recent gains.
Surging VIX Put Volume
What caught my eye today was a surge in VIX puts, as 65,688 contracts have changed hands so far, quadrupling the index’s average daily put volume. Most of this activity has crossed at the October 25 strike, which accounts for more than 40,000 contracts in volume. Digging into the numbers, there were several large blocks trading at this back-month contract. Notably, 17,000 contracts were traded at 10:27 a.m. Eastern time, followed by blocks ranging from 2,000 to 4,000 puts shortly thereafter. Open interest at the October 25 put current totals just 3,785 contracts, indicating that most of today’s volume will result in fresh open interest.
Delving a bit deeper, after totaling up the block trades crossing within seconds of each other at 10:27 a.m. this morning, I arrived at 40,000 contracts total. Just minutes later, corresponding blocks of October 30 VIX puts crossed the tape, totaling 20,000 contracts. If these trades were related, it appears that we have a form of bearish credit spread taking place on the VIX. However, confirming my suspicions proved futile, as nearly all of the volume for both the October 25 put and the October 30 put changed hands between the bid and ask prices.
Broader Implications
The more intriguing development here is the implication of this activity for the market as a whole. Looking at a chart of the SPX and the VIX, we can see that extremes in the VIX generally mark tops and bottoms for the SPX. Specifically, the May 15 low for the VIX marked a near-term peak in the SPX, while the broad-market indicator’s July 15 low was marked by a near-term peak in the VIX. Looking ahead, the VIX has begun to turn lower during the past couple of weeks, a move that has typically been a bullish indicator for the market.
Returning to VIX options, this speculative crowd has represented smart money during the past year. Specifically, peaks in the index’s Schaeffer’s put/call open interest ratio (SOIR) have corresponded to peaks in the VIX, and vice versa. For instance, the March 18 VIX top at 32.12 was accompanied by a near-term bottom in the indicator’s SOIR, with similar occurrences in late October 2007 and early August.
The Verdict?
Taking a page out of Todd’s Monday Morning Outlook playbook, “Declines in the VIX following climactic spikes have marked very good buying opportunities. Furthermore, the VIX has room to move significantly lower from here, as bottoms during the past year have generally occurred near the 16-18 area.” Taking the view that option trading on the VIX has been smart money this year, heavy attention to put options could be indications that the index should continue lower over the intermediate-term – a potentially very good sign for the bulls on Wall Street.
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