Once a month, there’s a big bout of trading that takes place around the CBOE Volatility Index. Two researchers think it’s a sign traders are attempting to manipulate the so-called fear gauge.
The VIX, as it is known, uses S&P 500 options prices to spit out a measure of expected stock market swings over the following month. Investors can’t trade the VIX itself, but they have have flocked to VIX options and futures, turning volatility trading into a large and liquid market. It’s become particularly pronounced as the fear gauge dipped toward its lowest level since the 1990s earlier this month.
As of last Wednesday, there was about $30 billion tied to VIX futures and options, a lot of which resided in expiring options, according to Macro Risk Advisors.
John Griffin and Amin Shams of the University of Texas at Austin contend that a quirk leaves the market vulnerable to a sophisticated trade that involves pushing around the prices of the underlying S&P 500 options in order to manipulate the value of VIX derivatives as they settle. Their research on the topic was published this week.
“The market design makes it potentially gamable,” Mr. Griffin said in an interview.
Not everyone agrees with that conclusion. The Chicago Board Options Exchange, which owns and calculates the VIX, says the work is based on “fundamental misunderstandings” of how VIX derivatives are traded and settled.
A spokeswoman for the exchange said in a statement that the trading they flagged as irregular “is entirely consistent with normal and legitimate trading behavior and is not evidence of manipulation. Also, CBOE takes seriously any market abuse, including manipulation of the VIX settlement process, and maintains a regulatory program that surveils for violative activity, and takes appropriate disciplinary action when warranted. CBOE’s regulatory program has access to, and considers, all relevant data and information, including data and information that is not available to academics like Professor Griffin.”
The bets on volatility made with VIX options and futures are settled in cash based on a VIX level determined at a special auction of S&P 500 options each month. At that auction, a large amount of trading takes place on the options used to calculate the VIX settlement level, but not on other options that are being auctioned at that time, according to the researchers’ analysis of data between January 2008 and April 2015.
The S&P 500 options market isn’t nearly as heavily traded as the VIX options and futures, which means that a relatively small amount of money spent buying or selling S&P 500 options has an out-sized effect on the settlement value of the VIX options and futures, they say. That would directly effect the amount of cash paid out at the settlement.
“This market is fairly unique because you’ve got a very liquid market that’s settling based on the price of a less liquid options market,” Mr. Griffin said. It has led to a potential opportunity for manipulation that isn’t available in most other markets, the researchers contend.
Here’s how they hypothesize investors could be taking advantage: An investor who, for example, owns $2 million of VIX futures and wants to push their prices up before settlement could spend $1 million overpaying for S&P 500 options at the settlement auction. That could drive up the prices of the contracts used to determine the VIX. Any money they lost by overpaying for the S&P 500 options would be gained back doubly because they increased the value of the VIX derivatives, where twice as much money is invested.
It is, of course, tough to rule out the possibility that something more benign is going on. For example, investors who had used the expiring derivatives to protect themselves could be seeking replacement protection when they participate in the auction, some say. Messrs. Griffin and Shams believe it’s not hedging activity due to the trading patterns they observed.
May 25, 2017 at 07:17PM
from Ben Eisen
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