The CBOE Volatility Index (NYSE:VIX), which measures the expected moves of the S&P 500, fell 3.8% on Monday to $14.26, its lowest close since June of 2007. It has fallen from levels above 35 since mid-November and above 45 since early October.
The big options trade was in the September VIX puts, where 15,000 of the 18-strike puts were bought for 72 cents and 73 cents and an equal number were sold at the 15 strike for 15 cents apiece. The volume at both strikes was well above open interest, indicative of a new opening position.
Those contracts are tied to September futures contracts, which closed at 24.74, down 5.5%. They haven’t traded for very long, but tested 30 on March 6, a day the spot VIX hit a high just above 21. Known as a bear put spread, the option trade cost a total debit of $0.57 to $0.58, and will earn more than 400% if the VIX settles at or below 15 in September.
The trade matches a recent pattern of investors buying puts on the VIX, thinking that volatility premiums are not justified and that the futures will collapse. Of the VIX options, more than half were puts, which is unusual because investors normally buy calls on the instrument to hedge long positions in the S&P 500. The total VIX options volume was 677,000 contracts, more than twice the daily average over the last month.
The iPath S&P 500 VIX Short Term Futures ETF (NYSE:VXX) also traded a record 744,000 options, of which 484,000 were puts. The iPath S&P 500 VIX Short Term Futures Fund made another new low on the day, and traders think it will get cut in half again by late summer.
Monday’s big trades were in the September 8-strike puts, with more than 20,000 contracts trading. They initially priced for 21 cents, followed by more buying at 22 cents. It appears that the trader is buying those puts with an expectation VXX will to collapse over the next six months.
The fund and other similar products are not based directly on the VIX because it can’t be traded. Instead it holds VIX futures, which have been in steep contango for months. That means each successive contract demands a big premium over the previous one. Monday afternoon, for example, with the VIX at 14.76, the April VIX futures were down 4.7% to 16.2 and the May futures were off 5% to 19.2. As a result, the VXX needs to constantly sell the cheaper future and buy more expensive contracts. That’s why it keeps dropping.
The fund declined 6.07% to $16.25 in early afternoon trading yesterday and closed down at $15.67. The index has been trending lower after failing at resistance at $50 late last year and is now at all-time lows. In addition to the contango factor, it’s also lost value because the VIX itself has fallen as investor sentiment toward equities improve.
Options volume in VXX has soared in the last year, and yesterday was triple the 120,000 average amount. Puts also outnumbered calls by almost 2 to 1. That’s an interesting contrast with the VIX, which normally sees more calls, and shows the kinds of headwinds this fund is expected to keep facing.
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