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Why the Sudden Rush to VIX Calls?

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Will a recent uptick in these bearish bets bode well for markets?

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Building on Schaeffer's Senior VP of Research Todd Salamone's commentary from this week's edition of Monday Morning Outlook , today I'm taking a look at the surge in CBOE Volatility Index (^VIX) call activity relative to put activity, and what it means for the market going forward.

As Todd noted, "Moreover, as you can see in the chart immediately below, the surge in the VIX's 20-day buy (to open) call/put volume ratio has been coincident with a decline in equities. In prior instances when this ratio trended higher, equities coincidentally rose, and our interpretation was that hedge funds were using VIX calls to hedge equity long positions they were accumulating. This pattern has changed, and we view the rise in the VIX call/put volume ratio as a sign of speculative bets against the market. In other words, we believe speculators are purchasing VIX calls in anticipation of profiting from a sell-off in equities that drives VIX futures higher."

The buy-to-open activity on the VIX is being driven by purchasers of VIX calls, so those expecting volatility to rise are well represented in the marketplace based upon recent trading activity.



And this activity continues unabated, as the VIX 10-day call/put volume ratio surpassed three calls for every one put this week, which is the first occurrence of the year.


So, if market participants are prepared for turmoil in the weeks ahead, what should you be doing now?

Paraphrasing Gerald Loeb and his classic book The Battle for Investment Survival, "You must see something ahead that is not reflected in the current price to bring about the expected advance in price. If everybody expects what you expect, there will be no profit."

One possibility that was highlighted by Todd, and may not be reflected in current prices, is that "any unwinding of these bearish speculative bets could be supportive of equities."

I will conclude this post with a summary of the S&P 500 Index (SPX) returns after a period of VIX call "anxiety," defined as a three-to-one call-to-put volume ratio over ten days.

Over one-to-three weeks post signals, the average returns beat the at-any-time returns over the same time frame, and after a few months the VIX speculators proved to ultimately be right (but early), with SPX returns falling below average.

I would like to note that VIX option activity gathered steam and became a prevalent form of hedging around 2008, so the returns below encompass both bear and bull markets alike. I also excluded redundant signals, as I used only one signal per every thirty trading days.





This article by Chris Prybal was originally published on Schaeffer's Investment Research.

Below, find some more great content from Schaeffer's Investment Research:


Weekly Contrarian: Do Bears Look Good In Coach?

Is Staples Due for Another Post-Earnings Nosedive?

Weight Watchers Traders Exploit Pre-Earnings Premiums


Twitter: @schaeffers
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