Whistle-blower alleges billions in VIX rigging profits
The claim sounds dubious: the VIX, that index at the center of the stock market's wild gyrations over the past week, is somehow being manipulated.
That allegation, made to federal authorities by an anonymous whistle-blower, captivated Wall Street on Tuesday, prompting both quick dismissals and more than a few raised eyebrows.
Cboe Global Markets Inc, the Chicago-based owner of the VIX, said the idea is preposterous. Many traders agree. Yet, after the burst of volatility and the three swings of more than 1,000 points in the Dow Jones Industrial Average last week, some are asking the question: What if?
The allegation has prompted second thoughts in no small part because global finance has a record of trying to manipulate all sorts of things, including benchmarks for interest rates and currencies. What's more, it’s not the first time someone has raised questions about whether the VIX is being gamed.
“It’s always been an ongoing conversation,” said Jim Strugger, a derivatives strategist at MKM Partners. With the meltdown of some VIX-related products last week, “obviously, there is more focus now. If there is proof of manipulation, that would be another huge blow for the vol space.”
An academic study last year purported to show the VIX settlement is subject to manipulation. Last month, Cboe also fined a Chicago-based trading firm following allegations it submitted improper bids to volatility auctions for emerging-market stocks and oil. On Tuesday, the Wall Street Journal reported the Financial Industry Regulatory Authority is looking into whether prices linked to the VIX have been manipulated.
Cboe, which has hired Finra to conduct surveillance of its trading platforms, declined to comment, as did Finra spokesman Ray Pellecchia.
VIX Manipulation Costs Investors Billions, WhistleBlower Says
There’s plenty at stake. Exchange-traded funds and notes tied to the VIX are worth about $3.5 billion, according to Bloomberg Intelligence analyst Eric Balchunas. Hundreds of thousands of futures contracts are in circulation, and are popular with hedge funds and other institutions.
Beyond that, there's the issue of financial-market stability. Some traders believe the wild session on February 5, when the US stock market suddenly went into a freefall before quickly recouping some of its losses — could've been fueled by VIX products.
In a letter on Monday to the nation's top markets regulators, the whistle-blower’s lawyer said that “unethical” market makers were whipping the VIX around without putting any money on the line, earning hundreds of millions of dollars a month in ill-gotten profits.
A flaw lets manipulators put in bogus quotes on S&P 500 Index options, which determines the value of the VIX, to opportunistically move it in one direction or another, the letter said. The client, who wasn’t identified by name, has held “senior positions at some of the largest investment firms in the world,” according to the client's attorney, Jason Zuckerman of Zuckerman Law.
Bill Speth, Cboe's head of research and one of the people who redesigned the VIX in 2003, said Tuesday the letter contains “a lot of mistakes and a lot of misconceptions.”
Market forces would probably stamp out any attempts at manipulation, he argued. If a rogue trader tried to sway the VIX by putting in questionable S&P quotes, arbitragers would quickly move in to profit from the discrepancies and move prices back to where they should be, Speth said. And practically speaking, the level of the VIX, it is just an index that you can't actually trade — matters less to traders than the prices of the derivatives tied to it.
“If you talk to any trader who's actively involved in the VIX, you know that nobody pays attention to the spot value,” he said. “There have been a number of times where the VIX futures and options have operated seamlessly in the complete absence of a VIX spot level.”