The biggest trade in options on the Cboe VIX Index Tuesday was an unusual $6 million purchase of deep, deep in-the-money-puts that might be an unusual interest-rate play ahead of Wednesday's highly-anticipated Federal Reserve rate decision.

Around 10 a.m. Chicago time, someone purchased 563 110-strike VIX puts expiring Oct. 21 for $5.1 million, as well as $1.2 million of the 130-strike puts expiring Nov. 18, the scheduled release date for next month's FOMC minutes. Not only was the premium more than any other single trade on the day, the choice to use extremely options so deep in the money – the VIX ended the session at 17.2 – with no open interest prior to Tuesday, is odd on its own.

Deep in the money puts have a much higher delta, or probability of expiring in the money, suggesting a high conviction that the VIX will move lower.
Taken at face value, it's a bet volatility will decline over the next two months. The 110-strike puts cost $91 each and the 130-strike puts cost $110 each, bringing the total breakeven on the trade to a little over $19.

That's if they were standalone positions, which most traders I spoke to said is unlikely to be the case. Their estimation of what else the trader might have on in connection to the trade, however, was varied.
"If someone is short a bunch of the calls, they may buy the puts and the futures to mitigate risk," Noel Smith, founder and chief investment officer of Convex Asset Management, said in a call. "People buy these tiny little VIX calls for 10 cents because if they go to 20 they can say they made a hundred. But the seller of those calls, they may have something else they want, but they have this wingy risk on the book they need to manage."
Combine the odd trade with other notable activity in VIX options, futures and S&P 500 options, and an argument begins to emerge that market-makers and big traders across volatility products are at odds over how to price the near-term range of outcomes despite the bond market saying an interest-rate hike is a 90% certainty.
Options volume in the VIX has been above average for almost a week as the gauge climbed to just over 18 at its high last Thursday. Yet swings in the S&P 500 have been below one percent for the past five days, despite the VIX holding above 16, which implies a daily move of one percent. At the same time, S&P 500 options are implying a move of 0.8% at expiry on Wednesday, unusually low for a Fed meeting.
If you believe the S&P options, and recent trading behavior, it would suggest VIX is too high. Similarly, the gap between the VIX index and futures as of Tuesday's close is near the highest since June.
The bizarre buyer of puts may be trying to take advantage of this by trading a spread between VIX options and the underlying futures, according to one explanation offered by SpotGamma's Brent Kochuba.
"You can own that super deep in-the-money put against a long call and long future position," Kochuba said. "As long as VIX is under 110, you can lock in whatever the difference in price is between the option and the future."