Friday night on the Option Pit Blog, I pointed out that while the CBOE Volatility Index ( VIX) was up quite substantially, especially on a Friday, VIX option premiums were actually down. This is extremely odd for VIX options as VIX options premiums normally increase as the volatility index rallies. However, on Friday, on a day when the VIX not only rallied, but rallied big, VIX option premiums were actually down.

Basically, if the VIX had a VIX, it would have read down on a day it should have been way up. To put things in perspective, for the VIX to be up over four points and options premium to be down is about as strange as if a 28-point sell off in SPX the VIX itself were down. This is that large of an outlier. The question is why would this happen?

When the market was selling off toward 1250, I wrote on several occasions how traders were 'brazenly' selling premium on the downswing and this could be the root cause of VIX premium selling off. Have traders found a 'better' product to sell premium in? Are there new VIX trading strategies changing the way VIX options volatilities move? Could it be that there was a large upstairs (OTC) trade and traders have been laying off risk in the VIX pit? Maybe there was something going on in SPX that was affecting VIX? The more I thought about the positions I have on, what other traders have on, and what I believe many of the major trading houses have on I think it could be something different.
In the last few weeks we have seen the market bounce between 1120-1190. During the first few trips IV was going lower and lower, but all of that has changed over last two rotations. In the last two weeks, it seems that even on rallies volatility is holding firm.

On my last trip to the CME, I ran into an SPX floor trader at the end of a decent up day. I asked him "were there premium sellers today?" All he did was look, laugh and shake his head no.

The point of the above anecdote is that even on the days where the market has rallied, traders have used this opportunity to buy somewhat cheaper protection. Those that already had protection have not been willing to sell it back. On the major down days, there is almost an all out dash for firms to get premium...until Friday.

I do not think that many firms were out selling premium on Friday, but we could have seen the first cracks of a somewhat 'fully-hedged' market. I am not sure but I think a strong case could be made that many firms own a massive amount of premium across many of the markets Combine that with many of the banks dumping long-term interest rate risk on the Fed (Do the Twist), and it is possible that the whole market is already hedged.

Obviously, if we have a huge 10%-15% down week I will be proven wrong, but if the market continues to 'only' move at 2% a day, the VIX is going to start selling off...if I am right (which is pretty 50/50 right now). There could be other mitigating factors that caused Friday (there is specualtion that a major market making firm is closing only right now and that alone would change that dynamic of every major indicator I look at).

What does this mean to the retail trader? I am not crazy enough to say it makes a ton of sense to sell puts right here. If you are still overall bearish, it makes a lot of sense to sell calls instead of buying puts, as I am not sure the trader is going to get the same 'lift' from a pop in vol and it is possible that if the market drops IV could still come in. In terms of the VIX, if IV falls below 90, I would snap up every option in that product I could buy.

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At the time of publication, Mark Sebastian held multiple positions in the VIX.