The Wall Street Journal is reporting this morning that “Turkey’s parliament approved a measure proposed by Prime Minister Recep Tayyip Erdogan, giving the government broad powers to send soldiers into “foreign countries” after Turkish armed forces and Syria traded fire on Wednesday and Thursday.” Though not literally a declaration of war, this is likely to escalate the conflict in Syria and could be the beginning of the end for the Assad regime.
During yesterday’s trading we saw large options trades on VIX futures betting that the “fear” index would remain in its current range through November expiration. One trader sold the Nov. 16-17 strangle and bought the Nov. 20 call 35,000 times for a net credit of $1.90. This trade is a bet that the VIX will be between 14.10 and 18.90 at Nov. expiration. Since a short strangle has unlimited risk this trader bought the Nov. 20 call as a hedge. By doing this the spread’s risk is limited to $1.10 on the upside no matter how high the VIX goes.
The VIX index is a measure of implied volatility in S&P 500 options and is negatively correlated with the market. Historically, for every 1% down move in the S&P 500, the VIX has increased by 4% on average. Therefore, by betting the VIX moves no higher than 18.90 this trader thinks a sharp decline in the S&P 500 is unlikely. Since September the VIX has been range bound between 13.51 and 18.96 and is currently in the middle of this range at 15.43. This trade is betting that this range will hold for the next 47 days until November expiration.
I like the way this spread was constructed because it has many of the attributes I like to see in my trades: a hedge to limit risk where the trade is most vulnerable, a favorable risk-reward ratio, and breakeven points that coincide with major support and resistance levels. The VIX is a mean-reverting index, and with its 50-day average at 15.79 there a very reasonable chance the VIX will still be near current levels at November expiration.