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June 19, 2017, 2:07 p.m. EDT

How S&P 500 options may be used to manipulate VIX ‘fear gauge’

Some $1.8 billion may have been transferred through VIX manipulation, study finds

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By Elliot Blair Smith, MarketWatch

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The Griffin and Shams analysis examines whether a “strategic manipulator” could profit by taking a position on the VIX, and then submitting aggressive orders for out-of-the-money SPX options that are used to calculate the index during settlement.

The evidence from January 2008 to April 2015 shows that “in days with large positive” deviations in the VIX settlement “the average indicative SPX price starts low” before the market opens, and creeps upward from 7:45 a.m. to 8:15 a.m. Designated market makers take over at 8:15 a.m. (now 8:20 a.m.), at which point prices typically go down, Griffin and Shams say.

However, they say, “aggressive orders before 8:15 a.m. still leave a significant effect on the settlement prices at 8:30 a.m., even after prices are partially corrected.”

A slight, temporary bump in the VIX is all that’s required to skew cash-settled derivative contracts, and would leave only the slightest trace in exchange records.

Griffin and Shams dug deeper to see if they could find evidence to support their hypothesis, and—although the CBOE disputes their finding—they think they did.

“First, at the exact time of monthly VIX settlement, highly statistically and economically significant trading volume spikes occur in the underlying SPX options,” Griffin and Shams write.

“Second, the spike occurs only in the (out-of-the-money) SPX options that are included in the VIX settlement calculation and not in the excluded in-the-month SPX options,” the academics contend. “Third, there is no spike in volume for the similar S&P 100 Index or SPDR S&P 500 ETF options that are unconnected to volatility index derivatives.”

CBOE Vice President of Research William Speth says Griffin “overlooks that traders legitimately seek to replicate VIX futures and options that will expire at final settlement, and to do so those traders logically will need to trade in the very options that Professor Griffin found, and in the same quantities and at the same point in time that Professor Griffin observed.”

See CBOE frequently asked questions about the VIX

Griffin told me he took those factors into account, and that “if the CBOE has more detailed data that they think would be useful to better understand and design the settlement, they should release such data to the public.”

Trading patterns in the European volatility index known as VSTOXX /quotes/zigman/210599224/realtime XX:V2TX +5.93%   are consistent with efforts to manipulate it also, Griffin and Shams say, although VSTOXX has a different settlement procedure. It’s calculated as the average of index values (captured at five-second intervals) between 11:30 a.m. and noon on the closing date, making it potentially more difficult to distort.

Manipulative trading in VSTOXX would have to be sustained for a half-hour, and optimally would occur every five seconds, Griffin and Shams state.

They examined VSTOXX settlement windows in increments of 100 milliseconds (one-tenth of a second), and discovered that settlement trades “clustered nearly exactly at five-second intervals” during the settlement period, but at no other point during the day.

Further, they found concentrated trading in inexpensive out-of-the-money options at the cutoff for consideration in settlement. Small price changes in the options could lead to them being included, or excluded, from the calculation. Trading volume in these options was about 130 times greater during settlement than in the rest of the day, the academics found.

A spokesman for the Deutsche Borse Group /zigman2/quotes/205502669/delayed DE:DB1 -2.83%  in Frankfurt, which created VSTOXX, did not provide comment in response to my questions.

I also reached out to Timothy Klassen, the chief executive of Volar Technologies, a New York firm that develops analytics for options trading, and who was a member of the Goldman Sachs team in 2003 that designed the VIX index the CBOE subsequently adopted.

Klassen told me he was aware of the vulnerability of the VIX settlement to potential manipulation, though he pointed out it “is harder in liquid markets,” and that “trying to manipulate the VIX is not conceptually different from trying to manipulate any other index product” that is dependent on underlying financial contracts or securities.

The CBOE itself seems to have been concerned since at least March 2008, when it issued a regulatory circular stating that traders submitting orders ahead of the VIX settlement “may not do so for the purpose of creating or inducing a false, misleading, or artificial appearance of activity or for the purpose of unduly or improperly influencing the opening price or settlement or for the purpose of making a price which does not reflect the true state of the market.”

CBOE spokeswoman Suzanne Cosgrove told me, “There are numerous structural safeguards built into the VIX settlement that make it difficult to manipulate, and our regulatory group actively surveils for potential VIX settlement manipulation.” Cosgrove also said: “CBOE has not made any regulatory findings that the VIX final settlement has been manipulated.”

In one other on-the-record comment, CBOE Vice President of Research Speth said: “Professor Griffin does not conclude that there has been manipulation of the VIX settlement, but rather just that it supposedly is susceptible to manipulation.”

Klassen himself says the VIX settlement process “almost certainly could be relatively easily improved.” He adds: “I don’t think any of the CBOE’s clients would be opposed to improvement to avoid manipulation.” None, that is, except possibly for a manipulator.

/quotes/zigman/210599224/realtime
XX : STOXX
29.78
+1.67 +5.93%
Volume:
June 30, 2022 12:00a
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/zigman2/quotes/205502669/delayed
DE : Germany: Frankfurt
154.75
-4.50 -2.83%
Volume: 100.00
July 1, 2022 10:59p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
N/A
Rev. per Employee
€555,390
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