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As the chart below indicates, this has been another roller coaster week for the CBOE Volatility Index [VIX].

The VIX began the week hovering around 25. Monday's session saw a brief spike in the index. However, subsequent declines in crude oil prices, along with corresponding rallies in the broad market, caused a steep decline in the VIX. By midweek, the index had declined over 10% to 22.60.

The VIX roller coaster took another turn on Wednesday as the downward trend quickly came to an end. Iranian missile tests sparked a new wave of concern over escalating tension in the Middle East. Continued saber rattling between Israel and Iran, along with renewed fears of a global economic slowdown, erased earlier market gains and sent the VIX rocketing skyward. The index regained all of its losses during the Wednesday session, leaving it nearly unchanged for the week.

The looming specter of war in the Middle East wasn't the only thing ratcheting up the fear level in the market this week. The end of the week saw renewed attention on the housing market. Fannie Mae and Freddie Mac triggered a sharp sell off in the broad market over concerns that these firms lack the capital to weather the current housing slump.

Rumors of a federal takeover of the two largest buyers of U.S. home loans sent the VIX soaring yet again. The index spiked to a high of 29.35 during Friday's session before finally closing at 27.51. Friday's session left the VIX with a gain of 10% percent on the week and a startling 22% percent gain from Wednesday's low.

VIX Options Activity

(data source: Trade Alert)

The Early Sessions (Mon 7/7- Thurs 7/10)

VIX options activity was extremely erratic during the past week. The wide range of movement in the underlying brought a correspondingly wide range of options strikes into play. The most active VIX option in the early sessions (7/7-7/10) was the July 32.5 call. This option traded 51,663 times with a slightly bullish bias on the week. The activity in this contract was strong despite the fact that it was over 30% out-of-the-money for most of the week.

As expected, the ATM July 25 and 27.5 calls were also very active during the week. 44,815 and 44,600 contracts changed hands respectively during the early sessions. Activity in these options was relatively neutral with neither a bullish or bearish directional bias.

Traders also spread their activity beyond the front month, with several August and October strikes also appearing in the top ten most-active list. 51,446 contracts changed hands in the October 35 calls. 32,091 Aug 30 calls also traded during the week. Neither contract had much of a directional bias.

It is worth noting that there was only a single put option in the top ten most-active list for the VIX during these sessions. The July 22.5 put traded only 20,913 times Mon - Thurs. This resulted in a put/call ratio of only .2 compared to the twenty-two day moving average of .31. This could imply more upside potential lies ahead for the VIX.

Friday's Session (7/11)

Friday's trading session also included some interesting activity. Volume was twice the average level as FNM & FRE continued to fuel broader economic fears.

The July 25 combo traded 5000 times in the early afternoon. The customer purchased the put and sold the call for a $2.30 credit (A combo is a synthetic underlying position. In this case, the customer bought the put and sold the call to create a synthetic short VIX position. Combos are a difficult and sometimes dangerous way to trade the underlying. They are frequently used to capture arbitrage profits against an underlying position such as the VIX future.)

The same strike also attracted the interest of straddle traders looking to go long front month volatility. The July 25 straddle traded 10,000 times late in the session for $3.20. There also was a significant buyer of the November 37.5 calls on Friday. Over 24,000 of these contracts traded on split prices for a net of $.725 at midday.

Aside from the November 37.5 calls, front month ATM contracts dominated the rest of the most-active list during Friday's session. The July 30 calls traded 29,528 times on the day while the July 27.5 calls traded 24,171 times. Neither option had a particularly bullish or bearish bias to their order flow.

Note: VIX options activity can be instructive for volatility traders and general market observers. However, it is important to remember that the VIX does not trade in a vacuum. VIX options are a popular way for traders in other products (SPX, etc) to layoff their volatility risk. VIX options traders should also keep an eye on the options flow in these other products to maintain a complete picture of overall VIX order flow.

Source: VIX: A Roller Coaster Week