Was the $VIX April Settlement Manipulated?

By Lawrence G. McMillan

Once again, there are questions surrounding the settlement of the CBOE volatility derivatives on this past Wednesday morning (April 18th).  There was what could be manipulative action on the $VIX settlement.  The day before, $VIX had closed at 15.25, and on Wednesday morning S&P futures were trading slightly higher, so logically $VIX would have been little changed or even lower.  However, on the “a.m.” settlement process for the April $VIX futures, the settlement was at 17.26, up over two points from the previous night’s close and more than two points above where $VIX itself was trading at the time!!  

What we do know is that someone bid for a very large quantity of out-of-the-money $SPX puts expiring in 30 days (those 30-day options, expiring May 18th, are what determine the settlement price), and that drove the price of $VIX higher.  The CBOE is, of course, aware of the criticisms in the past that the settlement calculation could be “gamed” by someone artificially raising the price of deeply out-of-the-money $SPX puts.  Hence, they have market makers ready to provide liquidity (i.e., sell).  This buyer, however, was so big –  $2.1 million dollars of puts with strikes ranging from 1200 to 1700 were bought – that liquidity providers couldn’t match him.  Thus these options printed at prices well above their theoretical values – they printed at 0.25 to 0.50, where they probably should have printed at 0.05 or 0.10.  That is enough to goose the $VIX settlement calculation.

Yes, that purchase of the $SPX puts is probably going to be a big loser, but did that put buyer own April $VIX derivatives?  Each April futures contract made $1,935 on that settlement calculation (that is, the April $VIX futures settled 1.935 points higher than they last traded on Tuesday).  Moreover, $VIX April 16 calls had been offered at 20 cents when they last traded, late in the day on Tuesday.  Suddenly they were worth 1.26 – more than six times that amount!  And, since these are cash-settled futures and options, one does not even have to trade out of the position.  

So now there will be a debate on what that buyer was doing.  Was he manipulating the $VIX settlement because he had other long April $VIX products – futures or call options?  Or was he simply a large hedged trader (Short May $SPX volatility versus Long April $VIX products) and thus had to unwind on the opening print by covering the May $SPX short Vol?  The CBOE will certainly be looking into it, but this takes time.  This topic has come up many times before – most prominently in February, when it made the national financial news for a day or so.  But it would be a hard case for the regulators to win.  

It seems to me that this question of manipulation could easily be quashed by weighting the contribution of  each strike to the settlement calculation, using the distance out-of-the-money.  At-the-money would get the most weight, and far out-of-the-money options wouldn’t get much weight at all.  In this way, the 1200 strike would get almost no weight and thus wouldn’t throw off the entire $VIX calculation.  A manipulator could not pull off the same game with at-the-money options, for they are far too liquid.  I don't know if that's been proposed.  Surely the CBOE would think of something like that; I can't be the only one.  

You’ll probably be reading more about this later.  There are already many articles on the internet, such as at Bloomberg, regarding this event.  This expiration tomfoolery even seemed to affect $VIX to a small extent the next day (Wednesday).

This article was originally published in the 4/20/18 edition of The Option Strategist Newsletter.