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Who's Behind the Strange Behavior of the VIX?


There's a big bet going on, to be sure.


As we know all too well these days, the "trading" VIX continues on with oddly strong behavior -- both in terms of futures premiums and OTM call speculation in size. Who's behind all this? Chris McKhann has some thoughts on the subject.

"These high levels in the VIX futures are driven higher by traders buying the futures, and the VIX calls in large size. The volatility levels must converge with the at expiration, so the volatility must rise (corresponding to a drop in the SPX) or the VIX and VIX futures must drop.

Many of us VIX watchers have been discussing this for the last several weeks. But let's think about who is behind these trades.

Jamie Tyrrell has discussed some of these trades recently in our Volatility Sonar reports, which are well worth listening to. We have seen trades involving the selling 20,000 of the November 25-27.50 'strangle' and buying 80,000 November 40 calls for $0.79 last week and again for $0.75 this week. We have seen one trade that involved selling 20,000 of the November 47.50 calls and buying 20,000 each of the 55 and 60 calls.

The risk in the former trade is roughly $25 million -- just in the VIX options. So we are not just talking about smart money, we are talking about the smart money. And it is likely that their VIX book tied it to other things and that there are complex hedges going on.

But make no mistake, they have a lot of money on the line and don't put on these trades with the intention of losing. The VIX may come down, and the VIX futures may drop, but that is not what that smart money is betting on.

I don't tend to engage in conspiracy theories and, while I know that market manipulation happens, I don't think it usually occurs on this large of a scale. But when I see this, I am reminded of the poker adage: 'If you can't spot the sucker at the table, then it's probably you.'"

There was also an old adage on the AMEX that if everybody is singing "Home on the Range" and you have no clue why, then someone probably taped some paper spurs to the back of your legs.

But I digress.

Chris is right in that there's a big bet going on. And they certainly can manipulate the VIX settlement, as last expiration so vividly demonstrated. Is there more than meets the eye though? I emailed the following to Chris.

"Just my theory, and I have no basis for this, but what trading desks are basically short gamma. It would make sense given the anemic realized volatility most of the last few months. And what if they're nervous about their exposure to a VIX pop, so buying all this VIX paper as insurance?

"I have no idea if any of that is true, just throwing it out as a possible explanation. It is indeed odd, all the call speculation on options so far away."

I think bottom line is, it's a combo of everything. Desks hedging overall volatility exposure combined with pure speculation on something resembling a rerun of last September.

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