Is the VIX Being Manipulated?
A conspicuous rise in the CBOE VIX last Wednesday has reignited a long-standing debate over the soundness of the Wall Street fear index. Now, traders are asking whether the VIX is just plain broken or being gamed by holders of derivatives.
The CBOE Volatility Index measures how much traders are willing to pay for options that are used to hedge against future stock-market declines. The so-called “fear index” normally trades inversely with the S&P 500 Index, which means it rises when stocks fall or vice versa.
On Apr. 18, the VIX spiked 12% in the first 30 minutes of trading, marking the biggest move since 2010, according to data gathered by Macro Risk Advisors and The Wall Street Journal.
The following chart, courtesy of WSJ, illustrates the dramatic surge between 9:00 a.m. and 9:30 a.m. The only comparable move after the opening bell occurred on Feb. 14, when the index dropped nearly 14%.
Since the VIX cannot be traded outright, investors use VIX-linked products to trade volatility, including options, futures and exchange-traded notes. VIX futures normally trade in a state known as contango, where the futures price is above the cash price and later contracts are incrementally more expensive than earlier ones.
An illustration of the structure of VIX futures contracts is presented below based on Friday’s closing prices. Contango is observed for the first six futures months.
Concerns Over Manipulation
While VIX’s sudden spike was supposedly tied to large orders for S&P 500 put options, concerns over market manipulation have been on the front burner for some time. Since February alone, at least nine lawsuits have been filed by plaintiffs arguing that the VIX is being gamed.
CBOE President Chris Concannon, who recently testified before Congress over cryptocurrency regulation, has said the allegations have impacted the monthly auctions process. He also said that CBOE is boosting its technical infrastructure to resolve these long-standing issues.
Concerns over CBOE’s options settlement process emerged last December after the exchange fined a trading firm over allegations of improper bids related to volatility auctions. The markets in question were tied to both stocks and oil. For its part, CBOE has denied that manipulation exists, with exchange officials arguing that the VIX settlement process offers a transparent auction.
Analysts warn that the VIX, while growing in popularity, is dominated by speculators betting large sums of money on how chaotic stock prices will be 30 days from now.
Volatility returned with a vengeance in early January and hasn’t left the market ever since. The fear index spiked so heavily in February that products shorting volatility were put out of commission. Credit Suisse pulled the plug on XIV, a popular inverse volatility product, on Feb. 20 after assets under management plunged from nearly $1.9 billion to $110 million in just six days.
Prior to the decline, XIV had performed extremely well during the bull market, with gains accelerating thanks to Donald Trump’s election.
Featured image courtesy of Shutterstock.