Investors Eye Options to Long VIX Amid Looming Uncertainties
In just two short weeks, the robust rebound in U.S. stocks has smoothed over the sharp declines seen at the beginning of August, leading the market to a state of "extreme optimism." Despite the calm, analysts caution that after a major quake, aftershocks often follow...
On August 19, Deutsche Bank strategist Jim Reid stated in a report that the market seems to have returned to normalcy, with panic quickly dissipating. The Nasdaq and S&P 500 have both risen for eight consecutive trading sessions, swiftly reclaiming lost ground.
The market's fear gauge, the $CBOE Volatility S&P 500 Index (.VIX.US)$, has also plummeted from its August 5 peak of 65.7, shedding 51 points to close at 14.65 on Monday, marking the fastest pullback in history. The VIX is now back to levels seen about a month ago.
Earlier this month, global stock markets plunged due to concerns over yen carry trades and a potential U.S. economic recession, sending Wall Street into a state of extreme panic. The VIX peaked at 65.7 on August 5, a level comparable to the highs seen during the financial crisis and the onset of the pandemic. On that day, the $S&P 500 Index (.SPX.US)$ entered correction territory but has since surged 8.14%.
Although the chaotic situation has subsided, concerns about aftershocks remain, as some factors that triggered the market sell-off have not dissipated. The VIX's dramatic reversal also indicates market sentiment instability, prone to swinging between swift optimism and sudden collapse.
August 5 was a major earthquake, and after major earthquakes, aftershocks usually follow—we expect them to occur frequently until the U.S. elections," said Jay Woods, Chief Global Strategist at Freedom Capital Markets.
What are the factors that could trigger market aftershocks?
Many of the drivers of the recent sell-off have not vanished, including the U.S. presidential election, weak global economic data, actual tightening of monetary policy, overvalued stock markets, and geopolitical concerns. The market still needs to be vigilant about potential future volatility.
Deutsche Bank's research points out that current U.S. stock valuations remain high. Investors are paying 21.16 times next year's expected earnings for the S&P 500 index, in line with early summer levels and above the 25-year historical average of 16.57 times. This means investors are still paying a premium for future profits.
The market is also facing a difficult period. Deutsche Bank macro strategist Henry Allen referred to September as a "very bad month."
Market historical performance
Late summer and September are often weak periods for the market.
Historically, the Vix tpically hits its seasonal low in late July or early August and then gradually ascends towards its seasonal peak, usually in October. This trend may be attributed to the fact that August and September—traditionally the two worst-performing months of the year in terms of average market performance—precede the VIX's October high. Data shows that the S&P 500 has declined in each of the past four Septembers and in seven of the past ten years.
Since 1989, VIX volatility in election years has averaged 2.67 percentage points higher than in non-election years. Monthly data shows that VIX volatility is highest in October of election years, reaching 23.75, followed by November at 23.57, and December at 21.8. This indicates that election factors increase financial market volatility .
Based on this historical experience, financial market volatility could further intensify in October and November. In U.S. politics, there is a term "October Surprise," referring to unexpected events in October that can change voter opinions, influence election outcomes, or reinforce one side's existing electoral advantage.
For example, during the 2016 election, the release of an audio recording of Donald Trump making derogatory remarks about women and the eruption of Hillary Clinton's "email scandal" both impacted the election landscape and shocked international financial markets. It is anticipated that U.S. financial markets will remain highly volatile leading up to the elections.
'50 Cent': A Volatility Play
In the world of trading, there's a figure known as the '50 Cent' trader, famous for occasionally purchasing massive amounts of VIX call options. This mysterious trader earned the nickname by buying VIX calls priced around 50 cents each, betting on a significant spike in market volatility.
Such a strategy has garnered attention because it exemplifies a way of profiting from anticipated volatility increases. By acquiring deep Out-of-Money (OTM) call options on the VIX, the '50 Cent' trader positions for potential gains should the market experience a significant surge in fear and uncertainty, like what we saw two weeks ago.
Interestingly, as we approach the traditionally volatile months of August and September—followed by October, which historically sees the VIX peaking—there's a growing curiosity among investors about whether adopting a similar approach could be advantageous. The past performance of these months suggests a pattern where volatility tends to rise, providing fertile ground for those betting on market upheavals.
While the specifics of such strategies are complex and require careful consideration, the actions of seasoned market participants like the '50 Cent' trader offer a glimpse into how some are preparing for potential volatility spikes.
Source: Bloomberg, Stock Trader's Almanac
Disclaimer: Options trading entails significant risk and is not appropriate for all customers. It is important that investors read Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Opening new options positions close to or on their expiration date comes with substantial risk of losses for reasons that include potential volatility of the underlying security and limited time to expiration. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including i potential for losses that may exceed the original investment amount. Supporting documentation for any claims, if applicable, will be furnished upon request.
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151262897 : Great article, very insightful.
BelleWeather : I’ve been buying UVXY shares as a hedge. May get some November calls…
Money Thrill : Great insight