Who is behind all the VIX trading?

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By Chris McKhann

The VIX and VIX futures still indicate that traders are looking for a pop in volatility, but it is useful to think about just who these traders are.

The VIX is back above 25, up 0.48 percent today to 25.04, while the S&P 500 is basically flat. The 30-day historical volatility of the SPX is still at 17 percent. This shows that traders are bidding up the SPX options, which is seen in that gap between the implied volatility (VIX) and historical volatility for the SPX.

More importantly, we see the VIX futures maintaining their premiums. The September futures are up 2.34 percent to 28.4, so they carry more than a 3-point premium over the spot value. The October futures are the highest and are up 1 percent today to 30.35, a 5-point premium over the spot.

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."