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Traders are betting big on a stock market shock

Traders are the most unhedged on the VIX since October 2015, which is a resounding bullish signal for the stock market fear gauge.

A live look at a trader seeking a stock market shock.

Volatility traders haven't been this sure of a stock market shock in almost two years.

These investors buy and sell options on the CBOE Volatility Index, or VIX, as they predict swings (or a lack thereof) in the S&P 500. The VIX typically spikes when stocks decline and falls in a steadily rising market. And right now traders are not betting that things will stay quiet. The cost of bets on a quiet market — used either as hedges by traders who expect volatility or as directional wagers on fewer price swings — is lower than it has been at any point since October 2015. That's relative to the cost of an increase.

In other words, volatility traders have taken the restrictor plates off their bullish VIX bet and are fully embracing the idea of a stock market shock.

This degree of confidence over increased turbulence has manifested itself in the exchange-traded-fund market. That's home to the iPath S&P 500 VIX Short Term Futures ETN, the biggest and most heavily traded VIX-linked product, which absorbed a net $219 million last month. To put the inflows in context, consider that the long-VIX instrument saw a $41 million outflow in the six weeks leading up to July.

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These latest developments come on the heels of several high-profile bullish VIX wagers.

The week before last, a mystery trader made a massive bet that the VIX would surge. If successful, it would yield a $262 million payout, according to a person familiar with the trade. The investor implemented a bullish call spread strategy using hundreds of thousands of VIX options.

And then there's the recently unmasked volatility vigilante, "50 Cent." That investor has been spending hundreds of millions of dollars to buy exposure on a VIX spike — but doing so in bite-size pieces.

VIX bullishness extends to Jeffrey Gundlach, the founder of the hedge fund DoubleLine Capital. He said last week that his firm purchased some five-month put options on the S&P 500 as the VIX sank to a record low.

"This is like free money," said Gundlach, who is known on Wall Street as the Bond King. "We are in a seasonally weak period for stocks, but more importantly we think the VIX was really, really low. So the S&P puts are going long volatility."

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