The Cboe Volatility Thesaurus (VIX) is often called the “fear gauge,” because market watchers use it to delimit expected volatility over the coming 30 days. It lived up to its personage on Feb. 6, when—following months of relative placidity—the index strengthened 199% from the previous day’s low to a high of 50.3. Volatility shorts, whose lays were facilitated by niche exchange-traded products, were wiped out: the VelocityShares Habitually Inverse VIX Short-Term ETN (XIV) fell 92.6% in a single session.
Allegations attired in b be committed to long circulated that some traders have their escapes on the VIX’s scale. On Feb. 12, following the market turmoil, Jason Zuckerman and Matt Review of Zuckerman Law, a K Street firm, wrote to the enforcement divisions of two financial regulators, the Refuges and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The literally laid out allegations of “rampant manipulation of the VIX index” on behalf of “an anonymous whistleblower who has favoured senior positions at some of the largest investment firms in the world.”
The manipulation, according to the letter, is non-stop and “costs investors hundreds of millions of dollars each month,” or $2 billion per year. The programme allegedly exploits a flaw in the VIX, which allows traders to influence the listing without risking any capital, simply by posting S&P options quotes. The profits from this motion amount to “multiple billions,” according to the letter. (See also: The SEC Whistleblower Program’s Restful Success.)
It further alleges that the manipulation was in part responsible for huge losses in VIX-linked exchange-traded products earlier in the month.
Cboe Worldwide Markets Inc. (CBOE) discloses the risk that the VIX could be manipulated, but Zuckerman Law entreats the disclosure “woefully inadequate,” given the length of the documentation—several hundred errand-boys—and the fact that there is no need to directly risk money to influence the choices quotes that determine the VIX, making the index “quite vulnerable.” The law solid therefore alleges “a breach of fiduciary responsibility” on the part of Cboe, which deserves 20% to 25% of its revenues from the VIX.
Cboe told Bloomberg that the scholarship precisely “is replete with inaccurate statements, misconceptions and factual errors” and ergo “lacks credibility”; a Cboe spokesman confirmed that statement to Investopedia. Spokeswoman Erica Richardson divulged in an emailed statement that the CFTC does not publicly comment on whistleblower gripes, which are “an integral part of the CFTC’s enforcement program.” A message formerly larboard at the SEC’s enforcement division was not immediately returned.
The Wall Street Journal blasted on Feb. 13 that the Financial Industry Regulatory Authority (Finra) is dig alleged VIX manipulation, calling the probe separate from the whistleblower’s call that regulators investigate.
Not the First Time
This is not the first interval the fear gauge has come under fire. A paper published in May 2017 by John Griffin and Amin Pastes of the University of Texas at Austin, detailed “interesting” patterns in trading linked to the VIX.
The index works by tracking the implied volatility of a range of S&P 500 sign options. Since traders buy and sell these options in order to hedge against or profit from coming moves in the market, the options’ implied volatility indicates the turbulence that buyers expect—if not necessarily the turbulence they get. (See also: Strategies to Trade Volatility Effectively With VIX.)
Griffin and Synthetics hypothesized that the VIX’s mechanics leave it open to manipulation. Say you have a lengthy position in VIX futures. If you’re willing to get your hands dirty to ensure a profit, you can submit “quarrelsome” buy orders for S&P 500 options during the pre-open auction period—7:30 to 8:15 a.m. CST—obliging up the index options’ clearing prices and with them the VIX.
According to the makers, this scenario is not just hypothetical. On settlement days for VIX derivatives condenses—at least in months when the VIX gains significantly— the price of S&P options has tended to be equal to until 8:15, suggesting they are being bid up in attempt to inflate the VIX. The figure then tends to list back downward for the final 15 la modes before settlement, when trading is only allowed in options dissimilar to open VIX positions. This movement indicates that “other merchants put in orders to sell the overpriced options and adjust the prices downward. Setting aside how, the prices are not fully reversed, and we observe more downward adjustment from adjustment to open.”
Images sourced from Griffin and Shams.
For example, ton options see increases in trading volume as expiration approaches. Not so with S&P 500 chances, for which trading volume spikes exactly 30 days old to expiration. “This is not due to any kind of obvious S&P 500 market-related event,” the writers write, “but it is the date that the VIX settles.” The authors also find that the peg in trading occurs only in out-of-the-money options, which factor into the VIX’s determining. In-the-money options, which don’t affect the VIX, barely budge. (See also: What Is Opportunity Moneyness?)
The authors explored two alternative explanations, hedging and pent-up demand for liquidity, but conclude that these do not make plain the patterns they see in the trading data.
Cboe emailed a statement to Investopedia in June 2017 declaring that Griffin and Shams’ work was based on “fundamental misunderstandings” of the forefinger’s mechanics. Patterns suggestive of manipulation are “entirely consistent with rational and legitimate trading behavior,” the statement said, and the paper’s authors were not privy to all germane data. “CBOE takes seriously any market abuse, including manipulation of the VIX payment process,” the statement added, “and maintains a regulatory program that surveils for violative liveliness, and takes appropriate disciplinary action when warranted.” A Cboe spokeswoman carry weighted Investopedia that the exchange has never taken disciplinary action against a blow-out for manipulating the VIX.
In an email to Investopedia, Griffin and Shams wrote, “Contrary to CBOE’s declarations, we have studied the VIX settlement thoroughly, presented our paper widely, and be struck by talked to various trading professionals who corroborate our understanding of the settlement get ready and findings.” They called on the CBOE to release any data “they muse over would be useful to better understand and design the settlement” to academics, “as is commonly done with other barters.” They expressed surprise at the Cboe’s “apparent defensive posture” and put about it was “disappointing that CBOE doesn’t seem concerned that satisfaction deviations are extremely costly to the investors using their products.”
In a Bloomberg column, Matt Levine put send on another, more “innocent” explanation for the apparent manipulation: traders irresistible cash delivery when their VIX derivatives expire (since medico delivery of volatility is impossible) and using it to purchase the underlying S&P 500 chances so as to maintain similar volatility exposure. “We do test that possibility as one our hedging premises in the paper,” Griffin told Investopedia. “We discuss it and rule it out as a complete disclosure.”
Writing to Investopedia, Griffin and Shams likened potential manipulation of the VIX to prior scandals surrounding LIBOR, gold, silver and the foreign exchange sell, “all of which were obviously gamed.” (See also: The LIBOR Skeleton in the cupboard.)