Reporters Fail to Distinguish Between Speculators and Hedgers in Option Trades

Can’t take it anymore. I’ve seen this too many times to not comment. Monday, a reporter for the Washington Post’s “The Ticker” wrote:

“At least one trader today placed a nearly $1 million bet that the VIX will rise above 45 by July, buying several thousand option calls.”

No, No, NO!

Just because somebody bought a million dollars' worth of options does NOT mean that that person thinks volatility is going to 45. People buy options for 2 reasons: speculation and hedging. There is simply no way to know from the information presented in the article that this VIX call buyer was a hedger or a speculator. If the person was a hedger, then by definition they think the most likely event is that volatility is not going to go to 45, but they want to be protected in case it does. They bought volatility insurance!

The author of this Bloomberg article makes the same mistake. In late May, with crude at 62.26, somebody bought a huge number of July 50 and 40 strike put options. Bloomberg writes:

“The number of options to sell oil at $50 a barrel for July settlement rose 22 percent last week to 24,948. Traders expect prices to fall because U.S. crude inventories are 1.8 percent below the highest level in two decades…”

Does that mean the put buyer thought crude was going down? Maybe. Maybe not. If the buyer was a speculator, then it was a bet on a decline. But if it was a hedger, then it could easily be a producer who simply wanted some price protection.

Let me ask you this question. When you own a house, do you wait till your insurance agent can see the flames coming out the window to buy homeowner’s insurance? Do you wait till you’ve lost control of the car to buy auto insurance? Do you wait till you’re dead to buy life insurance? Of course not. You buy insurance before the fire begins, before the wreck, before you’re dead. That doesn’t mean you expect the house to catch fire, have a wreck and die the next day, week or month. It’s protection put in place before a catastrophic event, just in case.

The fact that somebody bought all these options may, or may not, be representative of their true opinion on the direction of the underlying. Both authors are assigning a directional forecast to option trades when there is no way to know if those option trades are anything of the sort. They’re assigning a belief to something that may or may not support that belief.

One other point to make on that VIX article, and this is just so wrong I can’t believe it didn’t get edited:

“That trader won’t make money unless the VIX increases by 50 percent in a month, which would make for a volatile, and probably diving, market.”

The trader won’t make money unless VIX increases by 50%? Are you kidding me? Just because you buy a 45 call does not mean you expect it to go to 45. You get a move from 30 to 38 tomorrow and I’ll bet that call purchase makes money!!

That author’s statement is true only if you couldn’t sell or exercise the option prior to expiration. I think VIX options are European, so exercise is out. BUT YOU CAN STILL SELL THE CALL BEFORE EXPIRE!!!

Geez. Now you know why I don’t like talking to the media that much anymore. This is basic stuff, and this is Bloomberg and WaPo. Yet they still can’t get the easy stuff right, which means you’re probably reading things that simply aren’t accurate.

P.S. Note that I am not saying VIX won’t go to 45 and that crude won’t go to 40. Just saying that there is no way to know for certain that these are the opinions of those who made the gargantuan option trades.

Comments

[Alex F.:]

Don,

What's your opinion on the put/call ratio then in this context?

Jun 18 08:17 AM