A big part of my job involves discussing volatility and explaining that implied volatility for stock options tends to anticipate a stock price move while the volatility levels associated with index options is a bit more reactionary. Looking at the VIX curve below it appears that VIX may have been a bit elevated going into last week based on the employment number from Friday. That number was sort of a non-event as far as market reactions go and VIX dropped much like the volatility of an equity option post earnings.
A VIX option trade that was initiated on Thursday, before the Friday report, was bullish on VIX (bearish for stocks) and looked to February expiration. A trader came in and bought 110,000 VIX Feb 16 Calls and sold 110,000 VIX Feb 20 Calls. He wasn’t done with just these two call trades as he also sold 110,000 VIX Feb 13 Puts which resulted in a net cost of 0.14 per contract (in non-commission dollar terms this was 0.14 x 100 x 110,000) $1,540,000. The payout diagram appears below to clear this up a bit.
I highlighted the VIX index and February VIX futures pricing from Thursday’s close. Note that the best case scenario is a volatility spike that puts VIX over 20.00 at February expiration. VIX over 20.00 at February expiration would result in the spread being worth $44,000,000 (4.00 x $100 x 110,000) and a profit of $42,460,000. VIX between 16.14 (breakeven) and 20.00 would result in a partial profit and in the small space between 16.00 and 16.14 the trade results in partial loss as the long VIX 16 Call would have a little value to offset the initial cost. VIX between 13.00 and 16.00 and the trade loses that initial cost of $1,540,000. The real risk for this trade is VIX under 13.00 – at that point the call options expire, but the short VIX Feb 13 Put starts to work against the trader. For example, if the trade is held to expiration, VIX settlement at 12.00 would results in a debit of $11,000,000.