VIX rigging talk erupts on Wall Street after another wild swing

[NEW YORK] The Cboe Volatility Index or VIX is how Wall Street measures anxiety. Lately it's the gauge's own plumbing that's making people nervous.

It's a recurrent claim - the VIX is rigged. It got a fresh airing on Wednesday, when the index swung wildly just as derivatives on it were expiring. Billions of dollars are earned or lost as VIX futures settle. The concern is that owners of those wagers are willing to spend a few million to make them pay off.

The suspicions are only that, suspicions. Volatility markets are too complex for easy conclusions to be drawn, and reasonable explanations have been offered for the patterns. But strange-looking outcomes have happened enough on VIX settlement day that the debate keeps being revived.

Cboe Global Markets Inc declined to comment. Last month, Cboe CEO Ed Tilly said at a conference that "the integrity of our VIX products and markets is paramount. And, if our regulatory team were to uncover any manipulation, it would be rooted out, swiftly and decisively. Period."

Evidence the VIX is anything less than a pure readout on trader nerves would raise thorny questions for its overseers, who have succeeded in making it a central piece of Wall Street wiring. Its ability to turn stomachs was on display in February's stock correction, whose worst moments came when the VIX doubled and wiped out bets on calm.

"You have people watching and using it as a barometer for all sorts of trading decisions," Steve Sosnick, chief options strategist at Interactive Brokers in Greenwich, Connecticut, said by phone. "People take clues from what it's doing as to what the market's psychology is out there. But when the settlement time comes around, it can take on a life of its own."

Wednesday morning's events were sure to raise eyebrows. The VIX, which derives its price from S&P 500 options, was sailing along without incident until about 9am in New York, when it spiked as much as 11 per cent in about an hour's time. The jump coincided with a Cboe auction in which a monthly settlement value is set for the gauge, one that is critical to owners of some of the most popular futures in the country.

Both the settlement price and the high-water mark for the VIX index occurred more than 10 per cent above Tuesday's close - lucky, if you were betting on a gain. And people were. Large speculators hold record net-long VIX futures positions, according to the latest data from the Commodity Futures Trading Commission.

Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors, saw evidence the VIX was pushed higher intentionally. Among other things, roughly US$2.1 million was spent in the runup to the settlement on "extremely irrelevant" options that were tied to a 50 per cent drop in the S&P 500.

A trade of 13,923 May puts on the S&P 500, with a strike price of 1200, took place just as markets opened at 9:30am. Before Wednesday, the option was active only on five sessions in the past two months, with daily volume never exceeding 75 contracts.

"This feels odd. I don't think this is a coincidence," Mr Chintawongvanich said. "With all the concern about the possible VIX manipulation in February and then this happening today, it's possible that the regulators would look at it more closely. It appears to me that the instrument is vulnerable to people who want to push it up."

All kinds of claims have surfaced about the VIX's vulnerability and most aren't taken seriously by Wall Street pros. The ones focusing on the settlement auction tend to get more credence because of a study published last year by University of Texas researchers who said they saw evidence the process had been gamed, possibly by people holding derivatives.

It's a theory the Cboe has denied in the past, saying the trading patterns observed by the authors, John Griffin and Amin Shams, have explanations that require no illicit motive. Supposedly telltale volume spikes in S&P 500 contracts at auction are a natural result of traders replacing VIX futures with options exposure, not people trying to steer it.

"You can always find people that argue that this is just a normal thing to happen - market makers need to unload their inventory, and they happened to have too many far downside options this time around," Mr Chintawongvanich said. "These are all legitimate explanations. We'll probably never know who did it."

BLOOMBERG