Volatility may be the big business of the summer season, but few can play the cards

«Over fifty years of monitoring the markets have left me with an indelible deposit. For example, become a millionaire in a second and lose everything in a tenth of a second. Playing and speculating with futures is to launch Russian roulette. Now, the hardest is still playing at volatility. I met a famous mathematician who was short in the S & P in the 1987 crash. The index was blocked and money rained down from heaven. Another great manager lost everything in a second, to do the opposite two days later. It was late. You can lose everything or earn a lot while sipping a cup of coffee. Those of us who follow the day to day of the markets look forward to the reef, the great reef, the great vein of gold. But very rarely do we find it. There are actors who die without having found a single nugget of gold in the river of the Stock Exchange and the markets … »

«I’ve been thinking for several weeks that perhaps that reef, that great vein of gold is in the sudden roar of volatility. That roar that makes the money temple totter, the golden calf. The big problem is how to finance time, wait. We can not forget that volatility has been dormant for many months. Without flinching with anyone or anything. Volatility also depends on the hand of God, which rocks the cradle of markets and the Stock Exchange. That’s what I’m most afraid of: control of everything by that hand. We are guiñoles in and of almost everything. And of course, in the world of investment and the Stock Exchange. I insist, you have to have flats to get in front of the bull of volatility. I do not have them. I think most of my clients, either. And that is precisely what encourages me to think that the goose that lays the golden eggs, the big hit is in volatility,» the CEO of a major fund manager tells me.

An example that was cited a lot last year in the Great Wall Street Casino and its guiñoles (the rest of the world’s markets) was the gigantic bet of a mysterious trader that the volatility index CBOE – or VIX – would rise from the levels So low reached in October. The trader essentially extended that bet last December.

The rollover entailed that if the bet went well this trader would win 263 million dollars.

And considering that the trader lost only about 9 million dollars in the bet in the last September and October, extending the bet to December allowed him a continuous exposure to a potentially huge profit with a relatively small cost, according to a person familiar with the operation.

However, taking into account the propensity of the VIX to quote near historical lows, it is a risky bet. Let’s detail the operation:

– To finance it, the investor sold approximately 263,000 VIX expires in December with a strike price of 12.

– The trader used that income to buy a VIX 1 × 2 call spread, which involves buying 263,000 VIX December calls with a strike price of 15 and selling 526,000 VIX December calls at a strike price of 25.

– As a reference, bullish call spreads are used when a moderate increase in the underlying asset is expected. Traders buy call options at a specific strike price while selling the same number of calls of the same asset and expiration date at a higher strike.

– In a perfect scenario, where the VIX reached but did not exceed 25 before the expiration of December, the trader would earn 263 million dollars.

– It is possible that the VIX goes too high. If it increased beyond 35.2, the investor would begin to lose money, even though he could guess the direction of the movement.

– To put it in context, the December VIX futures quote around 14, while the cash quotes are around 10.7.

Difficult to understand and to manage, do not you think?