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VIX Options and Bullish Bets



VIX Options an Ideal Instrument for Hedging!


bullish bets

by Ian Harvey

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May 01, 2012

Introduction

It appears that a big theme at the present time, since the CBOE Market Volatility Index (VIX) is "cheap," as well as other various VIX products -- such as VIX options – at this present time, therefore, making ideal instruments for hedging equity portfolios.

VIX Popularity

It is quite evident that CBOE Market Volatility Index options have been steadily growing in popularity. For example:-

• In 2007, VIX contracts bought to open averaged nearly 28,000 per day.

• In 2011 the daily average was 75,000.

• In 2012, that figure has ballooned to more than 90,000 contracts per day, up from last year's daily average of 75,000.

Hedging

It is quite obvious that VIX options are most often used as hedging tools. When VIX call volume surges, so do equities, as VIX calls are frequently purchased as hedges by fund managers when they are accumulating stocks. As evidence of this phenomenon, the 20-day cumulative buy-to-open call volume on VIX surged from under 600,000 contracts to more than 1.4 million contracts from mid-December 2011 to early February 2012 -- a period during which stocks also exploded higher.

On the other side of the coin, VIX put buying surges and call buying falls off a cliff during periods of market weakness, as hedge fund managers begin to build their short exposure through increased equity shorting and decreased stock buying. For example, in August and September 2011 -- a period of severe weakness in the stock market -- the 20-day cumulative buy-to-open VIX put volume steadily increased from around 400,000 contracts to 1.0 million contracts, as comparable VIX call volume progressively declined from more than 1.4 million contracts to fewer than 800,000 contracts.

Headline Effects

During mid-March, VIX call buying was plummeting again, and VIX put buying was increasing. This shift in the options pits occurred prior to the resurfacing of negative headlines out of Europe and the ensuing April pullback.

Conclusion

This is exactly why it is important to continue paying close attention to option activity on VIX futures and major equity-based exchange-traded funds (ETFs) -- including the S&P 500 SPDRS ETF Trust (ARCA: SPY), Russell 2000 iShares Index (ARCA: IWM), and PowerShares QQQ ETF (Nasdaq: QQQ). By tracking the ebbs and flows of call- and put-buying trends on these popular hedging vehicles, you are able to get a real-time glimpse into the positioning of the major market participants whose actions have proven to ultimately determine the direction of equity benchmarks during the past few years.

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