The stock market may be grinding out new high after new high, but one trader is remaining steadfast on the view that turbulence is right around the corner.
Just six weeks after rolling over a massive wager that the CBOE Volatility Index, or VIX, would surge from its subdued levels by January, the volatility vigilante has essentially extended that bet into February. The so-called rollover carries the same maximum potential payout as before: an eye-popping $262.5 million.
Known to some as the “VIX Elephant,” the mystery investor has stubbornly clung to this trade since initiating it on July 21 of last year. That’s involved a pair of rollovers on September 25 and December 1, and now January 11.
The trader has lost just $45 million since first making the trade, according to data compiled by Pravit Chintawongvanich, the head of derivatives strategy at Macro Risk Advisors. That pales in comparison to the possible payout, which could go a long way towards explaining the person’s dogged persistence, according to another person familiar with the trade.
Pravit Chintawongvanich / Macro Risk Advisors
Still, it remains a risky trade, considering the VIX’s recent tendency to trade near all-time lows. The so-called fear gauge is down 12% in 2018 after falling 21% last year, and and investors continue to pile into the short-volatility trade, which has evolved into one of the market’s most crowded positions.
Let’s unpack the trade:
To fund it, the investor sold 262,500 VIX puts expiring in February with a strike price of 12.
The trader then used those proceeds to buy a VIX 1×2 call spread, which involves buying 262,500 VIX February calls with a strike price of 15 and selling 525,000 VIX February calls with a strike price of 25.
- Bullish call spreads are used when a moderate rise in the underlying asset is expected. Traders buy call options at a specific strike price while selling the same number of calls of the same asset and expiration date at a higher strike.
- In a perfect scenario, in which the VIX hits but doesn’t exceed 25 before the February expiration, the trader would see a $262.5 million payout.
- It is possible for the VIX to spike too much. If it increased beyond 35, the investor would start to lose money since the person used a call spread, even though the direction of the trade was correct.
- For context, VIX February futures are trading at 11.53, while the spot traded at 9.72 as of 11:58 a.m. on Thursday.
- All data is from Bloomberg and was reviewed by a person familiar with the trade.
There are a couple of potential explanations for the trade. The first is that the trader decided the prolonged low-volatility environment would end in the next couple of months. While it seems as though it could stretch on forever, even the longest stretches of subdued price swings have eventually given way to fluctuations.
It’s also possible the investor is simply hedging a similarly large bullish position on the US stock market. After all, the VIX trades inversely to the benchmark S&P 500 roughly 80% of the time, so a spike in the fear gauge would almost certainly accompany some weakness in equities.
And while this mystery trader is making waves with large bets, the person is not alone in wagering on a VIX spike. The trader known as 50 Cent — recently revealed to be affiliated with Ruffer LLP, a $20 billion investment fund based in London — rose to prominence with repeated bite-size volatility bets.
At this point, there’s no telling if the VIX Elephant will eventually throw in the towel, especially if they’re using this massive trade as a hedge. If the fear gauge doesn’t make the person money this time around, odds are they’ll just roll over once again. Stay tuned.