Some traders bet on a cataclysmic stock sell-off in December
Some traders are betting that the stock market will go into a cataclysmic selloff that could make the Covid crash look like a picnic.
According to Bloomberg, a trader recently placed a $30,000 bet that the CBOE Volatility Index, or VIX—known as Wall Street’s “fear index”—will shatter new highs.
The VIX typically trades on a scale of 10-80, with 20 representing the historic average. Anything above 20 implies that the S&P 500 will experience unusually high volatility—which is a precursor to a selloff.
This trader expects the VIX to clock in at 180 by Feb. 14; that’s a 1,100% increase from current levels.
The VIX has never traded above 100, and it hasn’t even been above 35 (extreme volatility) this year.
While it’s easy to dismiss this trade as ludicrous—after all, investors make crazy trades all the time—it’s not an isolated bet.
As Bloomberg reports, traders have opened more than 20,000 contracts for VIX December options with the same target. Just last week, 5,000 of those contracts traded hands.
Clearly, some corners of the financial market are taking this bet seriously—or using it as part of a bigger strategy.
A no-win bet
Anything above 30 for the VIX usually spells bad news for investors. Above 100? We’re looking at financial chaos.
As economist Paul Samuelson famously joked decades ago, the stock market has predicted nine of the past five recessions.
In other words, Wall Street is filled with doomsayers who use all kinds of metrics to predict recession, financial ruin, or worse.
These predictions usually have strings attached—an investment course, an insurance policy, or a “safe” investment like gold bars that the pundits are selling.
This particular VIX bet is interesting because traders are actually putting money where their mouths are. These bets are buried deep within the derivatives market—not on newspaper front-pages or CNBC’s Squawk Box.
But the real problem with betting on the VIX hitting 180 is there’s no practical way to profit from it.
“The problem with betting on the end of the world is that if you’re right, how do you get paid off on it?” asked Steve Sosnick, chief strategist at Interactive Brokers, a Connecticut-based financial services company.
How the VIX moves your 401(k)
Stocks and indexes that track the S&P 500 are some of the most common investments inside 401(k) accounts.
If the VIX spikes, the stock market usually goes in the opposite direction. This “inverse relationship” between the VIX and S&P 500 is observed about 75% of the time.
While investors shouldn’t be too worried about extreme bets on the VIX, monitoring the index could provide valuable information about how Wall Street views risk.
The VIX is currently hovering below 15—signaling stocks are still in a bull market. Americans are sitting on trillions of dollars in unrealized gains as a result.
Of course, the outlook on stocks and the economy isn’t all rosy. The same Americans sitting on trillions of dollars are also indebted up to their eyeballs—and the situation could get a lot worse with student loan payments coming due.
The U.S. economy is holding up surprisingly well, but stubbornly high inflation and rising energy costs could make personal finances more difficult to manage.