$89 Million Down, 50 Cents at a Time

James Tweeted yesterday:

Rather facetious, but the mention of VIX reminded me of a story I read earlier this month about a real trader nicknamed '50 cents' whose apparent daily strategy is to buy Call options in the aforementioned VIX.

"Basically they come in every day and they buy 50,000 VIX calls worth 50 cents. So in other words, they don't care too much what the strike is; they just pick the option that's worth 50 cents."

So far (as of 22nd April) the strategy has cost our friend ~$89 million, although it's likely a hedge with actual losses far less. 

The concluding two paragraphs caution against trying to work out the strategy:

It may be impossible to say for sure. At the same time, it's worth noting that tracking down 50 Cent's motives may provide little in the way of useful information.

"After 30 years in the business, I have seen far more money lost than made by speculation on 'other people's positions,'" Dennis Davitt, partner at Harvest Volatility Management, wrote to CNBC. "I find it is hard enough to make money just managing my own positions."

Apparently last Wednesday, 50 Cents doubled down:

On Wednesday morning, the trader bought an additional 100,000 VIX calls betting that the index will climb about 40% by May.

Goodness, at this rate we'll soon be talking real money.

The original CNBC article is here, and reproduced without the pretty pictures:

A pattern of huge, near-daily trades on the VIX is turning heads in the options market.

What's most notable is that even after losing some $75 million by betting on a volatility spike, the huge options buyer known as "50 Cent" shows no signs of slowing down.

"I would categorize them as someone who doesn't flinch at losing money," commented Pravit Chintawongvanich, head of risk strategy at Macro Risk Advisors, who flagged the activity in a series of research notes.

The money-losing trades in question have been purchases of call options on the CBOE volatility index. These represent bets that market volatility is set to rise, and to a lesser extent, that stocks are set to fall.

Sussing out the actions of an institutional trader based on public information about options trades can be difficult, if not impossible. But this trader made it easier by leaving a clue out in the open.

"They have a very particular pattern of buying options," Chintawongvanich explained Wednesday on CNBC's "Trading Nation."

"Basically they come in every day and they buy 50,000 VIX calls worth 50 cents. So in other words, they don't care too much what the strike is; they just pick the option that's worth 50 cents."

On Thursday, for example, 50,000 of the VIX 21-strike calls expiring in May were apparently purchased at a price of 49 cents. These options will expire worthless unless the VIX skyrockets 82 percent in a bit more than a month and a half, and will lose money unless the VIX closes above 21.49 on expiration (the VIX closed Thursday trading a bit below 12).

Since the multiplier on VIX options is 100, the purchase alone comes to nearly $2.5 million. In terms of the number of contracts, it was the single biggest trade of the day on any index or stock.

And that wasn't all. Also on Thursday, 15,000 May VIX 20-calls were traded at 51 cents, and 10,000 May VIX 21-calls were traded at 47 cents.

In total, the party that has become known as "50 Cent" after its favorite purchase price has spent about $90 million, and has already seen $55 million worth of purchased options expire worthless.

Unsurprisingly, this strategy appears to have a marked effect on the overall market for VIX options. Total VIX call open interest has risen to an all-time high thanks to 50 Cent's purchases, Chintawongvanich said.

A huge share of those calls have 50 Cent's name on them.

Ironically, the huge bets on the VIX could end up dampening volatility.

"50 Cent becomes very well hedged in a risk-off event, and would be in a position to provide liquidity for those scrambling for a hedge," Chintawongvanich wrote. "The presence of '50 Cent' could mean that future volatility spikes are muted."

In fact, Jake Weinig, founding partner at options-centric hedge fund Malachite Capital, commented in an email to CNBC that "the size is probably too big"; the very enormity of the trade "almost makes it a self-fulfilling prophecy that it won't pan out."

Of course, if it does pan out, the rewards could be sweet indeed. In 2008, the VIX closed above 80 on a couple days; looking at Thursday's $2.5 million purchase alone, a close at that level on expiration day would yield a profit of about $300 million.

So is this the case of a huge hedge fund quixotically betting it all on a volatility spike in the near future?

Perhaps, but the story is almost certainly not that simple.

"We think it's highly possible that this is some kind of systematic hedge run by a larger asset manager," such as a government pension fund, Chintawongvanich said. "Even though $90 million is a lot of money to us … in percentage of their total assets, it might be a lot smaller."

He added that "the persistence and the fixation on actual costs" suggests that "someone sat down at the beginning of the year and said, 'OK, we're going to spend this much on hedging our books every day. Go out and do it, and I don't care what you do — just spend this much money.'"

Further, the options trades may simply be one part of a broader hedging strategy.

Weinig theorizes that while buying VIX calls, 50 Cent is also betting against volatility in another form, such as VIX futures — which have indeed seen their share of shorts spike recently.

Selling futures "would cover the carry cost of the options, while still maintaining a nice tail hedge in an upside shock to implied volatility," Weinig wrote. "The event where this investor would lose would be in a slow and modest rise in VIX. As we haven't seen this in some while, our 50c friend remains unscathed for the time being."

In other words, the big purchases of calls may simply be the most dramatic part of a big asset manager's comprehensive plan to cheaply protect itself from a market crisis. Or, a bit more exotically, it may represent part of a fund's outright bet on a particular sort of volatility environment.

It may be impossible to say for sure. At the same time, it's worth noting that tracking down 50 Cent's motives may provide little in the way of useful information.

"After 30 years in the business, I have seen far more money lost than made by speculation on 'other people's positions,'" Dennis Davitt, partner at Harvest Volatility Management, wrote to CNBC. "I find it is hard enough to make money just managing my own positions."