VIX this, VIX that – why is it relevant? The CBOE SPX Volatility Index (VIX) has risen to prominence in recent years, especially among the options-trading crowd. No longer just seen as a "fear" barometer, defined by peaks and valleys, the VIX helps make sense of the wild world of options trading.
Lately, the chatter surrounding the VIX has been that it has been deflating. Since hovering around the 75 mark last fall, the index has slowly declined and is now perched in the 40 area. So what, you say? Well, yesterday, we were seeing two real-life examples in the financial sector of how reduced volatility can come back to bite call buyers, especially those holding out-of-the-money positions.
First up is JPMorgan Chase (NYSE: JPM, Stock Forum), which was up 10 cents to $32 yesterday, while the May 35 JPM calls were down three cents. They were crossing the tape at an average of $1.22 per contract. Volume was near 14,000 contracts, and it appears that the sellers had control of the pits. Open interest was 21,621. Interesting play by sellers given that we are likely to hear more about the bank stress tests before May expiration.
Even more interesting is Visa (NYSE: V, Stock Forum), which was nearly 1% higher in the first 30 minutes of trading yesterday, but the out-of-the-money May 60 call was virtually unchanged. Volatility is coming in on this stock, and what is even more notable is that V doesn't report earnings until April 29. It is typical to see volatility collapse after earnings hit the wire. Not so normal when it dries up in the days leading up the report. About 6,000 contracts changed hands in the first 30 minutes of trading yesterday on open interest of 6,562.
Now, we don't know if these positions are being sold-to-open or sold-to-close, and that really doesn't matter. What is important to note is that calls can still be in the red even if the underlying stock is flat or higher. The Black-Scholes model has five dynamic variables, remember, and volatility is among the most dynamic of all of them (along with stock price).
If you remain unconvinced, and think that volatility may ramp up before May expiration, there could be some good opportunities out there, as there is a decent supply of cheap options. But be wary … the VIX monster is holding some of the cards.