Grab Some Valium, VIX Still Rising

The great poet T.S. Eliot said he could find fear in a handful of dust.

Had the poet, who once worked as a banker, began around today he would have instead pointed to the options market’s fear gauge, the Chicago Board Options Exchange’s Market Volatility Index (VIX). The VIX tracks the implied volatility of Standard & Poor’s 500 Index options. When investors want to hedge their portfolios they buy index options, which influences VIX.

On Friday, when the stock market tumbled sharply lower, VIX ratcheted sharply higher on aggressive put option buying. Remember, puts increase in value when stock prices decline. Put buying also drives overall volatility.

Everyone knows that VIX gained about 23% Friday, and nearly 10 points, or 52% week-over-week.

Perhaps not surprisingly, investors are positioning for VIX to increase further still. Jim Strugger, MKM Partners‘ derivatives strategist, told clients this morning that more than 500,000 VIX options traded Friday, the second-busiest day in the past 12-months. On Friday, the three most popularly traded contracts were the March 25 calls, and the April 50 calls and February 50 calls.

It’s hard to see VIX trading as high as 50 before April expiration, but remember these trading patterns because they say an awful lot about the delicate state of the market’s most sophisticated investors.