The VIX is pretty much color blind, it doesn’t differentiate between bullish or bearish activity. Simply put* If the market starts buying a bunch of calls (which is usually bullish), the VIX goes up…if the market starts buying a bunch of puts (which is usually a bearish trade), the VIX goes up. Over the past years it’s usually been a lot of put buying that drove the VIX higher and higher.
However now, people are using options much more as a capital enhancement tool and less as a capital preservations tool. Thus people are overwriting positions more than they ever have in the past. According to Denis Davitt (head of NY Options Trading)lately he has seen a ton of call selling in the options market. People are coming in and overwriting their calls and the markets been grinding at this steady pace into these long volatility positions. Basically everyone is long volatility. While VIX traded 14 today, (near 52 week low today & the difference between puts and calls is at a 4 yr high) that’s not necessarily a bullish indicator if anything it may be bearish because people are willing to pay up for puts relative to calls … click chart for a full size view>>>
The VIX index is a measure of 30 day implied volatility. The CBOE calculates the VIX as a weighted average of next term and near term S&P 500 option volatility. As volatility increases and decreases the number of options used in the VIX calculation expands and contracts, so the portfolio of options used to replicate the VIX is ever changing which makes the index non-investable. In order to *try* to replicate a long position in the VIX, you want to go long a representative portfolio of 2 month or less (preferably 30 day) puts and calls while delta-hedging the position daily. My suggestion was to delta hedge a simple straddle at the front month or the front two months of S&P 500 options. I deem that a sufficient replication for going long a representative version of the VIX. Will it follow the VIX exactly? No. But in trading I always tend to error on the side of simplicity.
*The many layers to the VIX can’t be simply put, for a deeper look check out the VIX White Paper below