VIX CHART
Quick – the green candle in VIX on Friday.
After meandering for the week, the CBOE Volatility Index (VIX) exploded 24% on Friday, the largest single day pop for those seeking options trading information since those Flash Crash days of May, 2010.
What’s it all mean?
Well of course, we won’t know until this plays out. But it’s not uncommon to see rushes for volatility like this on Fridays. And that sounds odd, because normally Friday is the worst day of the week for VIX. That’s because on a typical Friday, an options buyer worries most about the time decay he has to pay on his option longs. So he lowers his bids, which translates to modestly lower readings in a volatility index such as the VIX.
On the flip side, options sellers generally lower their offers as well on Fridays, knowing that if nothing much happens, they earn three days worth of decay on their sales. When you spend a day seeing nothing but riots on the TV though, you naturally think less about the relative pennies you might collect on decay than you worry about the relative dollars you may fork over on an ugly gap down on Monday. At best you raise your option offers, at worst you chase and cover your option shorts. And of course as option prices increase, the next guy gets squeezed and covers, and before you know it you have a veritable VIX stampede.
Nowadays we have another factor: Weekly Options. The closer an option gets to expiration, the less premium in that option. The less premium, the less cushion for the option short to absorb an accident. The less cushion, the quicker the short has to defend the position, either via stock sales or option buys (or both). Now that we have Weeklys, we have extra option shorts out there with the potential to get squeezed. It’s not a huge factor yet, but it is something that can push moves further on the margins.
The fear is apparently that Egypt will cause some sort of domino effect. We see these fears play out all the time. Last year it was the PIIGS (Portugal, Ireland, Italy, Greece, Spain) and the Euro “contagion”. In past times we’ve seen it in Latin America and the Far East. All tend to run their course as far as the market is concerned, and I have little doubt this one will too. Who knows how long that takes though. I noted last week that we get lots of fake breakouts in VIX that run counter to the prevailing trend for every one real breakout. My inclination is to fade the VIX breakout via put and put spread sales in index options, with disciplined stops in case this is in fact the real one.
Follow Adam Warner on Twitter @agwarner.
