Some marquee money managers are looking pretty smart right now

Investors and traders who bet market volatility would return are feeling pretty good right now. On Thursday, the CBOE Volatility Index (^VIX) spiked to 15.5 from 11.7 on Thursday, ending one of the longest stretches of low volatility we’ve seen.

The VIX is derived S&P 500 index option prices. When volatility increases in the markets, all things being equal, the premiums of options also rise. And so, one easy way to trade volatility is to buy put options cheaply when volatility is low and then sell those options at a higher price when volatility spikes.

This week, we learned in 13-F regulatory filings that a bunch of big-name hedge funds including JANA Partners and Tourbillion Capital had loaded up on put options on the SPDR S&P 500 ETF (SPY). Just last week, DoubleLine Capital’s Jeff Gundlach told CNBC that he had bought put options on the S&P 500, saying it’s “like free money.”

Indeed, with volatility at multi-decade lows, these money managers were probably able to buy these put options at unusually low prices.

Ari Wald, the head of technical analysis at Oppenheimer, observed that bets were tilting heavily toward put options with the composite Put/Call ratio recently reached its highest level of the year.

A slide from Ari Wald’s August 12 research note.

While this reflects bearishness in the markets, Wald notes that this is also a contrarian indicator that signals a bullish move in the markets may be building.

“We use this fast-moving option-based data as a sentiment indicator meaning high levels indicate high pessimism which from a contrarian viewpoint we consider as a market positive,” Wald wrote in an email to Yahoo Finance on Wednesday. “With an increasing number of firms playing for market downside we see the firepower to propel a rally should positive news develop.”

Smart money loads up on put options

Hedge funds loading up on these put options could be a bet on stock prices falling. Puts gain value when the price of an asset falls. Buying these SPY puts gives the fund the right, but not the obligation, to sell shares at a set price. If the underlying asset that it tracks falls, the funds should profit as they would effectively be able to buy at a low price and then sell at the put’s price.

Perhaps, more importantly, it’s also a bet on volatility rising. While volatility has remained low, it’s also meant that the premiums for these put options has tumbled. If volatility spikes, the funds can sell these options on the market for a potentially large profit.

On Thursday, stocks sold off while the Volatility Index (^VIX) spiked, meaning this could be a timely bet for many of these funds.

Hedge fund legend Paul Tudor Jones’ hedge fund owned puts on 2.25 million shares of SPY. During the second quarter, Tudor Investment Corp. increased its bet, buying puts on 774,400 shares.

Paul Tudor Jones, founder and chief investment officer of Tudor Investment Corporation (REUTERS/Eduardo Munoz)

Steven A. Cohen’s family-office Point72 Asset Management also increased its bet, buying put options on 650,300 more shares in the quarter, so that the fund last held puts on 2.78 million shares. Sprott, the Canadian-based hedge fund, also adding to its bet, buying puts on 2.31 million shares in the quarter, bringing its position to puts on 2.9 million shares.

For some well-known hedge funds, put options of the SPY was their biggest position in the quarter. Some of those funds include activist investor Barry Rosenstein’s JANA Partners’ with options on 2.32 million shares; SAC Capital alum Jason Karp’s Tourbillon Capital’s with puts on 2.5 million shares; Donald Sussman’s Paloma Partners with puts on 3.52 million shares; and Owl Creek Asset Management’s with puts on 3.43 million shares of the SPY.

Others trimmed their stakes, but still held large positions. Meritage Group sold puts on 1.1 million shares of the SPY during the second quarter, but still held puts on 3.1 million shares at the end of the quarter. Pine River Capital Management, the hedge fund operated out of Minnetonka, Minnesota, trimmed its stake, selling puts on 1.39 million shares in the quarter and last holding puts on 2.95 million shares.

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.