Investor sets portfolio for next round of debt squabble

Options trader pays $6.7 million for trade that hedges against spike in volatility.
OCT 22, 2013
An investor paid $6.7 million for a trade that will pay off if the Chicago Board Options Exchange Volatility Index more than doubles by February. The trader on Friday bought 160,000 bullish contracts on the VIX expiring in February with a strike price of 24, while selling the same number of February 29 calls in a strategy known as a call spread, according to New York-based Trade Alert LLC. The trade profits if the volatility gauge rises above 24.42 from the current level around 13, data compiled by Bloomberg show. It has a maximum payoff if the VIX jumps 115% to 29. “This is probably an investor with a portfolio of stocks who is using the VIX to hedge against an increase in market volatility,” Frederic Ruffy, a Chicago-based senior options strategist at Trade Alert, said in a phone interview. “The focus is on the February options, so it expresses concern over what will happen during the next three months, which coincides with the next deadlines on the government budget.” Congress resolved a deadlock on funding the U.S. government and avoiding a default this week, driving the VIX down from a three-month high of 20.34 on Oct. 8. The agreement funds the federal government through mid-January and lifts the nation's debt ceiling until Feb. 7. The VIX, which hasn't closed above 29 since the end of 2011, slumped 3.3 percent to 13.04 today, a one-month low. The purchased February 24 calls cost 90 cents per contract, while the February 29 calls were sold at 48 cents. The total cost of the trade was 42 cents per contract, or $6.7 million, according to data compiled by Bloomberg. Stock insurance The VIX is “an attractive alternative as insurance but a tricky one to manage,” Justin Golden, a partner at Lake Hill Capital Management LLC, said in an e-mail. The New York-based hedge fund trades options on equity indexes and commodities. “It's not a simple buy-and-hold format for hedging.” The VIX, an options-based measure of the price to protect against losses in the Standard & Poor's 500 Index, soared 23 percent in the five days after the government shutdown began at midnight on Oct. 1. The volatility index then tumbled 21 percent for the biggest drop in more than two years on Oct. 16 after lawmakers agreed on raising the debt limit. Traders profited on Oct. 16 when the most-owned contract on the VIX, November 14 puts, soared 129% as the gauge tumbled. About 1.1 million VIX options changed hands on Friday, exceeding the average over the past four weeks. (Bloomberg News)

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