If options traders are correct, stocks are in for a wild ride in February.
Demand for one-month call options tied to the CBOE Volatility Index, a popular gauge of stock-market volatility, has spiked in the past week, a sign that some are bracing for a sharp downturn following the inauguration of President-elect Donald Trump.
In that time, investors have purchased 250,000 VIX call options with a strike price at 21, and another 100,000 with the strike at 22, according to Brian Bier, head of sales and trading at Macro Risk Advisors, an options brokerage. The options cost roughly 49 cents per contract, Bier said.
By comparison, the CBOE Volatility Index
was at 11.16 in midday trading on Friday as the Dow Jones Industrial Average
and the SP 500
were on track to record modest daily gains.
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It would take a massive selloff to make these options profitable, Bier said.
Call options represent bets that the level or price of a given asset or index will rise during a given time—in this case, the period between Friday and Feb. 15, when these options expire.
Investors frequently use VIX futures and options as a hedge against volatility. That way, if stocks tank, they can offset some of those losses with the profits from their options trades.
“Even in the current low volatility environment, we’ve seen a lot of people still looking at the VIX as a hedge,” Bier said.
Since the beginning of the year, stock-market volatility has been relatively subdued despite increasing uncertainty surrounding the future direction of fiscal and monetary policy in the U.S. The Daily Shot, a popular market newsletter, illustrates this divergence in the chart below.
Aside from the beginning of Trump’s first 100 days in office, a period where investors expect Trump to begin implementing his plans for infrastructure spending, trade and deregulation, there are no clear market-moving catalysts, Bier said.
Another reason for the increase in demand for one-month VIX options could be that they’re cheap relative to three-month, six-month and nine-month options, Bier said.
“Investors are getting advantageous prices on hedging in the short end of the curve,” Bier said.
Since touching a five-month high on Nov. 4, volatility has trended lower as U.S. stocks embarked on a torrid rally that took the Dow to within a hair’s breadth of the 20,000 milestone last week. But stocks have struggled to build on their gains this week, and some Wall Street analysts are saying that the inauguration could mark a near-term top.
Trump will take the oath of office on Jan. 20.