The coronavirus outbreak is sparking extreme demand for market protection, according to XFA’s Bill Looney.
“The VIX alone trades forward implied volatility. So, when you buy deep out-of-the money calls, you’re basically betting on a disaster kind of move which we’re somewhat seeing now,” Looney told CNBC’s “Trading Nation” on Tuesday. “[It] becomes a form of portfolio insurance.”
The VIX is considered the market’s fear gauge and reflects future volatility over a monthly time span. VIX call strikes are typically attractive to traders when they think an intense leg lower is coming.
“The coronavirus has injected what we would classify as an ‘unknown unknown’ set of fears,” Looney added. “This is a very fluid situation.”
His observation comes from the market’s front lines, where he helps facilitate trades on behalf of large institutional clients.
Looney suggests options activity is signaling wild swings will last a while.
“Traders are not ready to take that off just yet, given the moves and given that fact that everyone is telling us roughly four to six weeks before we have a true idea of the impact of this virus,” he said.
On Monday when the Dow fell 1,031 points, Looney noted the massive move led to 39 million options contracts trading — one of the highest volume days ever recorded.
“We have yet to see this insurance come off or profits be taken,” Looney said.