To The Moon

The calm in the U.S. stock market was shattered on Tuesday, with the $S&P 500(.SPX)$ plunging over 2% and the $Cboe Volatility Index(VIX)$ soaring. This volatility spike netted an options trader around $12 million in profits by Friday night.

The $Cboe Volatility Index(VIX)$ jumped due to a tech stock sell-off dragging down the $S&P 500(.SPX)$ . $NVIDIA Corp(NVDA)$ gapped down 2.8% and continued to slide, ending 9.5% lower at a three-week low of $108, shrinking its market cap by $279 billion.

On Friday night, an investor spent nearly $9 million buying 350,000 $Cboe Volatility Index(VIX)$ call spreads to hedge against market risks.

These spreads—Buy calls with a strike price of $22 and sell calls with a strike price of $30, both expiring on September 18—cost 25 cents each. By Tuesday, as the VIX surged from under 16 to nearly 22, similar spreads were trading at around 60 cents each.

Market chatter suggests the Friday buyer might have sold their position, though specifics are unclear. Regardless, the potential profit is about $12.25 million. This Bull Call Spread strategy proved to be a fantastic low-risk, high-reward play.

What’s a Bull Call Spread?

A Bull Call Spread involves buying a call option at a lower strike price and selling another call option at a higher strike price, both with the same expiration date. Compared to simply buying a call, it reduces net premium outlay and shifts the breakeven point to the left, increasing the chances of profit. Essentially, it's a low-cost way to bet on an upward move.

Bull Call Spread Explained

• Maximum Profit: Achieved if the asset price hits or exceeds the higher strike price. It's the difference between the strike prices minus the net cost of the options.

• Maximum Loss: Equal to the cost of the purchased call minus the premium received from the sold call (i.e., net cost).

Risk and Reward: Compared to buying a call outright, a Bull Call Spread has limited risk and reward. The maximum loss is known upfront and equals the initial net cost of the options.

This strategy is suited for investors expecting a moderate rise in the asset price but not a huge leap. It’s effective in markets with lower expected volatility, allowing for gains while keeping option costs down.

Bull Call Spread Example on the VIX

The VIX is currently priced at 20.72. If you believe the market might plunge further and the VIX could skyrocket, a Bull Call Spread could be a good strategy.

Step 1: Buy a VIX call option with a strike price of $22 and an expiration date of September 18 at a cost of $184.

Step 2: Simultaneously sell a VIX call option with a strike price of $40 and expiration date of September 18 receives the premium of $77.

The transaction involved buying $Cboe Volatility Index(VIX)$ calls with a strike price of $22 and an expiration date of September 18, while selling $Cboe Volatility Index(VIX)$ calls with a strike price of $40 and an expiration date of the same date.

Data from Tiger Community

1. Cost Analysis

-Buy a VIX call option with a strike price of $22: Cost is $184.

-Sell a VIX call option with a strike price of $40: Receive a premium of $77.

Net Cost: $184 - $77 = $97

2. Maximum Potential Profit

To calculate the maximum potential profit, consider the difference between the strike prices minus the net cost.

Maximum Profit: $1,690 - $97 = $1,583

3. Risk Analysis

The maximum risk is the net cost paid, which is $97. If the VIX is below $22 at expiration, all options become worthless, and you lose the entire premium paid.

4. Breakeven Point

The breakeven point is the VIX price at expiration where the trade breaks even. Calculate it as $22 + $1.20 = $23.20. So, if the VIX is above $23.20 at expiration, you’ll start making a profit.

Summary

This Bull Call Spread is ideal if you expect the $Cboe Volatility Index(VIX)$ to rise moderately in the near term. It’s a solid choice if you think market volatility will increase significantly before expiration, pushing the VIX above $23.20.

If you foresee further market drops, this strategy to bet on a higher $Cboe Volatility Index(VIX)$ could be very rewarding.