On Thursday, September 13, 2012, I turned to the CBOE page to research a new product offering. Before I could continue with my research, I noticed a bulletin dated two days earlier. On September 11, VIX index options had set a new record for the biggest volume for a single day. More than 1.2 million contracts VIX options traded.
What did that mean? For newbie traders, the VIX is a volatility index that usually trades in opposition to the SPX. It's not an exact market timing tool, but when the VIX reverses, the SPX often does, too, within a few days to a week. Since the VIX had been dropping and the SPX climbing, did that mean that the SPX was about to reverse?
Let's think about it and put that day into context. The next day, the German Court was due to rule on the constitutionality of the bailout plan for the eurozone and Apple was due to release new products. The day after that, September 13, the FOMC decision and press conference were scheduled. Were market participants betting on a big move or hedging against one?
The article didn't say. It did say, however, that the previous record had been August 5, 2011.
VIX on August 5, 2011:
On that August 5, 2011 day of previous high volume, the VIX, at least, was about to reverse directions, spend a time churning, and then continue lower again. During that same immediate post-August 5, 2011 period, the SPX would chop around in a volatile manner at the bottom of its range, drop lower one day and then begin its long climb off the summer of 2011's lows.
Okay, that got our attention. Last weekend, as I was roughing out this article, I had a question to ask myself. Was a big VIX move about to occur, and which direction would it be, if so?
The article made no mention of whether those trades tended to be heavy in VIX calls or puts, whether they were bought at the ask or sold at the bid. Were they mostly short-term SEP options betting on an immediate move or further out ones? Could complex orders be matched up?
The article didn't say that, either. I went hunting, knowing that much information is available to us on the CBOE and other exchange sites. It took only a second to locate a Volatility 411 report from September 11 that remarked on the busy day in the VIX pit. Right away, I noticed that the article's summary mentioned "steep contango." What is contango? In this case, it means that the further-out options have more implied volatility than the closer-in ones. That's normal for some options contracts although some contracts see the opposite effect, backwardization.
Mike Palmer presented that Volatility 411 report. Being on the floor, he was able to provide more information. "The big trade," he noted that day, "is October 30/35 call spreads." He pointed out that they had seen "roughly 200,000 [buyers of those spreads] over the last week," with those spread buyers paying between 10 and 16 cents for that spread. He noted that they had also seen big numbers of a strangle composed of NOV 18 puts and DEC 24 calls strangles versus the OCT 26 calls. His conclusion? Traders were buying volatility--betting on or hedging against a steep rise in volatility--in the three- to six-month range. However, they were closing near-month trades and "becoming less fearful about the near future." Hence, the steep contango.
That didn't seem to presage an immediate big move in the VIX either direction, did it? The thought seemed to be that most buyers believed we have a big move in the future, but not right now.
Those who were closing out their short-term volatility trades before the German Court and FOMC decisions perhaps turned out to be right. We certainly didn't see an expansion in the volatility indices and a rollover in equities as a result of those decisions, did we?
However, volume was up again in both VIX options and futures on September 13, the day of the FOMC decision. What can we find out about what occurred that day with VIX options and futures?
VIX futures had "followed suit" on Thursday, September 13 by trading at record volume. CBOE instructor Russell Rhoads noted in his article, "Record VIX Futures Volume Today," that the record futures volume occurred in the following month-by-month breakdown:
Month-by-Month Breakdown, from Russell Rhodes' article:
Extrapolating from that earlier information, can we presume that some traders were closing SEP trades and rolling into OCT ones? Because we're brainstorming, we have to think of all possibilities. For example, we see that volume in SEP futures and OCT futures is nearly equal, both heavy. Is it possible that some of the activity represents some participants rolling from SEP into OCT positions? That might not say much about direction, especially since we don't know from that table what was sold and what was bought. With the VIX nearing strong support at the time, the obvious suggestion would be that a reversal upward is expected, but is that the only possibility? Of course not. Rhoades didn't speculate, either.
Fortunately, another Volatility 411 video was produced that day. This time, someone else on the floor, Jamie Tyrrell, noted that the contango had flattened again. November futures had moved down $1.50 as compared to the September futures, he noted. The bet was apparently off that volatility would rally and equities roll lower. He did note that some customers were "coming for some protection, 40's and 50's," but said that action was less than he'd seen in previous cycles.
So was the big VIX move that might be in the making as of September 11, when those options first hit a new record, a drive lower in the VIX? The VIX was then holding near 16 even though SPX values were rallying. The commentator on September 13 thought floor was being put in beneath the VIX with options trades "discounting a move below 14 and 15" but increasing the likelihood that the VIX would stay in the high teens and not move higher than that.
I was left scratching my head, but I do remember something I had read long ago, in a little book with bad production values: Master the Markets by Tom Williams. The book spent much of its time hyping an expensive trading system, but Williams had a great grasp of market behavior. He warned that high volume and little movement was often a sign of a market top or bottom. In a rising market, for example, if the volume was high but there was little movement higher, then sellers were surely coming in and selling into that big volume. In a downdraft, if there was high volume but little movement downward, buyers were often coming in and overwhelming the sellers, so that they couldn't push it lower. In this case, it was the VIX that wasn't being pushed much lower despite market rallies and big VIX options and futures volume.
Of course we know now what has happened since then. As I edit and revise this article on September 21, the VIX measures 13.84 while the SPX measures 1462.33. There wasn't a floor under the VIX after all at 14-15, but it's expiration week, and I expect some strange VIX behavior on the expiration week of monthly SPX options. The SPX hit a new recent high of 1474.51 on September 14, and since has traded sideways to sideways down.
What's the lesson we could have taken with us when we learned about the record high volumes on VIX options and, subsequently, the futures? A first takeaway is that we options traders now have many tools available to us that would not have been available years and even months ago. Few among us would have had access to a floor trader who could provide us with the information that the contango was flattening and that there appeared to be a floor under the VIX for the immediate period, even if traders were loading up on those call debit spreads for October. Those floor traders provide us with pertinent information but also offer an explanation or interpretation. Believe me, I don't always understand how much contango is normal in any one contract. I know people who study skews all day long, but I do not have the time to do that nor do I want to do that. However, I remember being worried that period of September 11-13 about the possibility that markets could keel over if the news was unexpected. This sort of news helped put a floor under my own worries, too.
I don't like to trade the VIX options or futures because of their wonky behaviors, but I do like to watch the volatility measures. They give me some idea of the underpinnings of the markets. We can participate in what's happening on the CBOE's floor in a way we never could previously. In their effort to provide content, exchanges have provided us with unprecedented access. Because my current trade is fairly well hedged both directions, I haven't hunted through the CBOE's page for information this week, but you might check it out on the CBOE page for yourself. Has anything changed? What about all those who bought those call debit spreads? Are they unloading them, thinking that the VIX is going to stay low for a long while? Or, are they reloading, preparing for a bump up in the VIX and perhaps a downturn in the SPX and other markets? Access to all this information, including Volatility 411 is free, although in some cases a free registration is required.
One caution. You'll find lots of information from other traders and even from some on the CBOE site about trading VIX options and other VIX products, such as the VXX. There's a whole bunch of wonky stuff (technical term) going on with these volatility products. I don't like to trade them. Promise that you'll read the products page and learn as much as you can before you consider trading these as I know traders who have had their heads handed them on a platter when trading these products. I don't include them as a part of my trading, but I do watch the behavior of the volatility indices, and that's all I'm encouraging you to do.