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Lessons from the U.S. stock rout: options hedging pays

Stock MarketsFeb 12, 2018 03:40PM ET
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© Reuters. A trader works on the floor at the New York Stock Exchange (NYSE) in Manhattan, New York

By Saqib Iqbal Ahmed

NEW YORK (Reuters) - Months of subdued U.S. stock market gyrations seemed to relegate options hedging into a futile and expensive trade, but last week's huge spike in equity market turbulence quickly reminded investors of the virtues of defensive options.

Last week, forward-looking measures of volatility soared as the S&P 500 Index (SPX) tumbled over 5 percent.

The spike in volatility meant that a mysterious U.S. equity option trader, dubbed "50 cent," who spent millions on a recurring Cboe Volatility Index (VIX) options hedge over the last year, saw the position finally pay up.

VIX options are primarily used to protect against a stock market pullback.

"The persistent buyer of VIX call options that we have been tracking finally made money – and how!," Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors in New York, said in a note.

The spike in volatility meant that "50 cent," so called because of a tendency to pay a fixed price of 50 cents for blocks of VIX call options, made about $400 million mark-to-market this month, according Chintawongvanich.

Chintawongvanich estimated that the trader, who had been employing this rolling hedge since at least January 2017, made a total profit of about $183 million on the options position, as of Friday.

The trader likely took significant losses elsewhere, since the VIX options position was probably a hedge against potential losses in a much larger portfolio, rather than a naked bet on higher volatility.

It was not immediately clear whether "50 cent" had closed the options position to monetize the gains.

Another anonymous trader whose position was large enough to earn the nicknames the "VIX elephant" and the "VIX whale," closed out a recurring position of more than a million VIX options.

Taking into account the rolling position initiated in July, the trader is up roughly $40 million on the VIX options position, Chintawongvanich estimates.

Still, traders were not rushing to load up on options hedges.

Open positions on the options on popular hedging vehicles SPDR S&P 500 ETF Trust (P:SPY) and S&P 500 Index (SPX), on Monday, show traders' preference for protective puts at multi-month lows, according to options analytics firm Trade Alert data.

"There are many signs of complacency amidst this shock," Jim Strugger, derivatives strategist at MKM Partners in New York, said in a note.

Lessons from the U.S. stock rout: options hedging pays

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