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Conspiracy "Fact" - VIX Manipulation Runs The Entire Market

Tyler Durden's picture




 

Ever since Simon Potter's 2012 arrival as head of The NYFed's trading desk, the manipulation of VIX (and thus its reflexive levered tail wagging the algo-driven dog of the indices) has been front-and-center day-after-day in the so-called US equity 'market'. Since the introduction of VIX ETFs there has been an almost inexhaustible supply of conspiracy theory coincidental evidence of a mysteriously well-capitalized market participant always willing to step on the neck of any volatility-spike, thus protecting poor market participants from any prospective plunge. While only fringe-blogs have noticed this in the past, now The FT admits that not only was recent volatility in markets exacerbated by VIX ETFs (thus confirming the tail-wagging-dog analogy), and further, the nature of the link between VIX ETFs and VIX Futures (rebalancing) enables frontrunning which serves to reinforce any trend into the close and thus manipulate the markets.

 

Since Simon Potter's arrival at The NY Fed in 2012... the rather amusing correlation between the collapse in net VIX futures non-commercial spec interest (yes, the traded VIX, which courtesy of the New Normal's relentless synthetic reflexivity has a huge impact on the trillions in underlying assets: think massive leverage) as per the CFTC's weekly commitment of traders report, and the arrival of Brian Sack's replacement as head of the NY Fed's trading desk, Simon Potter, the same former UCLA Econ PhD who recently delivered a very ornate speech explaining central bank interactions with financial markets "through the prism of an economist." Now at least we know how said "interactions" look outside of "Market Manipulation for Econ PhD Dummies" and in practice.

 

So-called VIX-terminations have bcome ubiquitous...

VIXtermination: Vol Banged To Lowest Close Since June 2007

VIXterminated - Fear Collapses By Most In 31 Months

Mickey Mouse Market Pops-n-Drops As Crude Carnage Follows VIXtermination

Volumeless VIXtermination Fuels Stock-Buying Frenzy To Record Highs

Biggest Short Squeeze Since 2008 Bank Bailout And Epic VIX Rigging Sends Stocks Green For The Week

Which all look - to some extent - like this...

VIX ETFs were screwed with...

 

To ensure S&P closed Green!!!

 

And notice the noise in VIX from this week...

 

But, this ability to exaggerate the upside of any momentum, has its downside. 

As The FT reports, the upsurge in stock market turmoil during August was exacerbated by specialised exchange traded funds that track volatility and use leverage to magnify investor returns, according to some analysts.

 

Some analysts argue that the magnitude of the move in the Vix was fuelled by certain types of ETFs, and similar exchange traded notes, that track the index but use futures contracts to multiply investor’s returns.

 

There is rising concern over the bigger role played by passive or systematic trading strategies in equity markets — given the current uncertain global economic and financial backdrop — with some fund managers arguing that their techniques are aggravating market movements.

 

Four products, two run by ProShares and two run by VelocityShares, totalling $2.8bn in assets, bought close to 35,000 Vix futures contracts on August 24, according to calculations from public data by Macro Risk Advisors, a broker dealer. Total trading volume in the futures contracts that day reached 569,000.

Which explains the unprecedented record net longs in VIX Futures...

Speculative traders have never - ever - been this net long VIX futures... and traders have not been this net short S&P futures since Summer 2012.

 

It's all great when VIX is getting smashed lower - and implicitly stocks surged higher - but it appears the only "volatility" that gets any real attention is "downside" moves...

“It exacerbated the move higher in the Vix, and has contributed to high volatility in the Vix itself,” said Pravit Chintawongvanich, a strategist at MRA. “Volatility of Vix at one point reached 2008 levels. The effect of levered ETFs is one reason that the Vix is less useful as a barometer of financial stress than in the past.”

 

BlackRock, the largest mutual fund in the world, has previously warned about the risks of levered ETFs, and in a policy paper in July reiterated recommendations, “that these products not use the ETF label”.

And the manipulation is simple and cost-effective...

Futures contracts only require a small amount of money, or “margin”, to be paid up front to cover potential losses, rather than having to pay the full amount of the investment, allowing an ETF to buy a larger value of futures contracts than investors have paid into the fund.

 

For example, investing $100 in an ETF offering twice the returns of the Vix futures index will mean the ETF provider buys $200 worth of futures. If the price goes up 10 per cent then the investor receives 20 per cent back, or $20. The investment is now worth $120 and the ETF is worth $220, so at the end of the day it has to go out and buy another $20 worth of futures contracts to maintain the same leverage for the next day.

But here is the potential for froint-running and manipulation (especially from a deep-pocketed vol seller)...

It requires ETF providers to buy as prices rise and sell as prices fall, which critics claim exacerbates market movements, filtering back into the closely-related options markets that the Vix is priced from.

But providers of levered volatility products played down the relationship.

There is a layer of separation between the Vix and Vix futures, and the ability to uncover any effect is challenging,” said Scott Weiner, head of ETP quantitative strategy at Janus Capital, which own VelocityShares. “It’s a small impact, if at all.”

The CBOE, which runs the Vix index, said that it allows investors, including ETFs, to agree trades during the day where the price is determined by the settlement price of a contract once the market closes, allowing ETFs to rebalance without having a significant impact on the price... and critics say this does not work...

because the amount ETFs need to rebalance each day is publicly disclosed. “If people know someone has to buy in large size at the end of the day, then they will simply buy the contracts ahead of them,” said Mr Chintawongvanich. “It has the same effect.”

So, whether by direct manipulation (sparking the most modest of momentum knowing that VIX ETF rebalancing into the close will extend any move), or learned rigging by the algos (following the same pattern), it appears yet another conspiracy theory become conspiracy fact.

*  *  *

But there is a silver lining to the recent smashing of fingers trapped trying to pick up pennies in front of steamroller...it appears The VIX Manipulation has begun to lose its mojo...

A 1.5 vol crush in VIX managed a mere 6 point rise in the S&P 500 (20% of what would have been expected!!)

 

 

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Sat, 09/19/2015 - 14:05 | 6569398 Dragon HAwk
Dragon HAwk's picture

More and More people reading Zero hedge..  it's harder for the main stream Media to Lie.. and that's a good thing...

Sat, 09/19/2015 - 14:27 | 6569439 junction
junction's picture

Drudge Report has a link to a Gallup Poll that shows tha 75% of Americans think the government is corrupt, putting the USA in 12th place, behind mostly third world nations.  That is sort of news most lying American reporters will never cover.  Happy talk rules the television airwaves, at CNBC, CNN and FOX, among other government mouthpieces.

http://www.gallup.com/poll/185759/widespread-government-corruption.aspx?...

Sat, 09/19/2015 - 14:56 | 6569494 El Oregonian
El Oregonian's picture

Use your God-given discernment in deciding truth. Obviously, what is being puked out by the "official" paid-propagandist talking heads is nothing more than an illusionary pile of stink'in crap. 

Sat, 09/19/2015 - 15:21 | 6569561 Pool Shark
Pool Shark's picture

 

 

"A 1.5 vol crush in VIX managed a mere 6 point rise in the S&P 500 (20% of what would have been expected!!)"

 

So, somebody is front-running the front-runners?...

Sat, 09/19/2015 - 21:12 | 6570310 0b1knob
0b1knob's picture

"VIX Manipulation Runs The Entire Market"

You misspelled "Ruins". 

Sat, 09/19/2015 - 16:39 | 6569759 Bay of Pigs
Bay of Pigs's picture

Interesting that Russia is not on that list.

Sat, 09/19/2015 - 17:35 | 6569878 sun tzu
sun tzu's picture

On the other hand, it appears many Europeans are delusional, thinking their governments are not corrupt

Sat, 09/19/2015 - 14:08 | 6569407 Soul Glow
Soul Glow's picture

I was going to make a joke about Kevin Warsh but it might be a little over done at this point.

Ah fuck it, and fuck you Warsh!

Sat, 09/19/2015 - 14:20 | 6569425 Consuelo
Consuelo's picture

 

 

Glad to see this again (as nearly the same substantive information was posted here almost a year ago).   Henceforth, all future 'VIX' articles should be preceded by a 'disclaimer' of sorts - or at least a reminder that the reader should be aware that the VIX is a (fill-in-the-blanks) indicator which should not be interpreted as adivce to buy or sell, blah-blah, FINRA regs & all that stuff...    Might as well just start calling this shit for what it is...

Sat, 09/19/2015 - 14:33 | 6569452 ebworthen
ebworthen's picture

This, and paper gold, and the marekts - nothing is tangible.  Just like the FED's "targets", ever-moving, ever-fungible, speculative mumbo-jumbo. 

Waning cash usage, littlle screens and big screens flashing perceptual candy - so little of it tangible or tethered to reality.

Sat, 09/19/2015 - 15:43 | 6569638 TwoHoot
TwoHoot's picture

Well said.

And hedges are hedged. and then the hedge hedges are hedged again. Reality fades away. All is random. Entropy wins.

Sat, 09/19/2015 - 14:32 | 6569454 max2205
max2205's picture

It's a shit show 

Sat, 09/19/2015 - 14:34 | 6569457 Amish Hacker
Amish Hacker's picture

Goose the open, frontrun your clients, bang the close. Who knew it would be so easy to do god's work?

Sat, 09/19/2015 - 14:41 | 6569469 Multivariate Man
Multivariate Man's picture

Can someone posting here succinctly explain why and how VIX futures control the cash price?  Why is there a linkage and how does it operate?  Thanks.

Sat, 09/19/2015 - 15:40 | 6569627 playdoh
playdoh's picture

In simple terms. VIX is used to hedge, e.g. buy stocks plus buy VIX futures in case of market turmoil. You get plenty of 'bang for your buck' protection if the market crashes.

Much of today's trading is done by machines. They are programmed to auto-hedge, VIX is an integral element. Force down VIX to convince the programs it's safer to buy more stocks and you will lift the cash price of stocks. The same 'bank for your buck' applies when manipulating stocks higher.

What the article here misses is the big players know where they can take the market to run stops and cause short-covering, etc. If you're looking to why the VIX effect isn't having the desired influence you need to look at the bigger picture.

Sat, 09/19/2015 - 16:35 | 6569754 Cthonic
Cthonic's picture

Arbitrage.  Only way to cancel out short volatility (selling a vix future) is by synthesizing the long equivalent out of spx options.  Changes in the prices of those options feed back into the VIX index calculation.

Sat, 09/19/2015 - 17:52 | 6569936 t-bonkers
t-bonkers's picture

The idea that the vix futures somehow control the cash price is rediculous. The vix is calculated by the spx options that are either being bid up or sold off. The futures are based on supply and demand regarding the markets expectation of future volatility, but settle to cash at expiration. Look at how the vix spiked on black monday. Notice that it took the futures almost a week to catch up. I don't believe in algo manipulation, and I just don't buy that there are any opportunities for arbitrage. 

 

Sat, 09/19/2015 - 14:44 | 6569475 Fed-up with bei...
Fed-up with being Sick and Tired's picture

I ACTUALLY OWNED THE VXX...2000 SHARES...GOT KILLED.  I kept selling calls against this position, until two weeks ago when I got out at break even.  I had no fucking idea about it and actually saw my shares plunge to 14 bucks (close) and then it doubled recently, and I got out at 28.35...WHEW!

Sat, 09/19/2015 - 14:51 | 6569491 q99x2
q99x2's picture

Great articles. I saved them.


Sat, 09/19/2015 - 14:52 | 6569493 Jason T
Jason T's picture

It seems to WTF a lot.

Sat, 09/19/2015 - 14:53 | 6569499 holdbuysell
holdbuysell's picture

How does the VXX have a record 100%+ of its shares short while the VIX net spec longs are at an all-time high?

I'm confused.

Sat, 09/19/2015 - 15:20 | 6569564 Amish Hacker
Amish Hacker's picture

That's why Jamie Dimon has more money than you do.

Sat, 09/19/2015 - 16:00 | 6569674 falak pema
falak pema's picture

Is VIX made by L'Oreal or by COty?

Sat, 09/19/2015 - 16:19 | 6569716 earleflorida
earleflorida's picture

there is no safe harbor

all channels have been mined

Sat, 09/19/2015 - 17:19 | 6569825 permarig
permarig's picture

Kinda suspected a connection between the Fed's VIX short and to the Oct. 15 market plunge earlier:

Comment 6308904 at
http://www.zerohedge.com/news/2015-07-13/how-high-frequency-traders-brok...

Updated chart with the recent plunge (it was pretty similar):

https://pbs.twimg.com/media/CN0neyEVAAAQuqQ.png:large

Sat, 09/19/2015 - 17:47 | 6569916 Lucky Leprachaun
Lucky Leprachaun's picture

They will continue to waste money manipulating… until the day that it all collapses around their ankles in an embarrassing heap. On that day, Gold and Silver will show their true value.

There is one problem; there are thousands of industrial processes for which Silver is vital, and has no replacement. That smartphone you are holding, being one of them. The Chinese had a trial run in refusing to supply rare earths to Japan, to see how twitchy the West would get about it; as we did nothing to support Japan, I think you can whistle for those vital industrial ingredients, when the time eventually comes.

Sat, 09/19/2015 - 17:47 | 6569917 polo007
polo007's picture

According to Bank of America Merrill Lynch:

https://app.box.com/s/2x1jqc1901tv8v00mbqnqjfbu8rrqzzp

The HY Note

Global growth concerns spread from us to Fed

A slow moving train wreck

Today’s Fed decision was the second worst outcome for risk markets, in our view. We have written on numerous occasions that if the Fed didn’t hike rates today initially markets would rally modestly before selling off. The realization that global growth concerns are not only real, but very dangerous right now should cause a risk off environment. And with no room to cut rates, we question the Fed’s ability to manage any further slowdown through what would have to be QE4. However, we can’t see how additional quantitative easing will help, as the goals of QE have already played out: the banking system has recovered, rates are low, investors have driven debt issuance and asset prices to uncomfortable levels, and the housing market has recovered enough to not be a concern.

Furthermore, lower rates don’t help high yield at this point. Whether the 10y is at 2.20% or 2.0%, does the asset class really look all that more compelling? Not in the slightest. In fact, outside of hiking while sounding very hawkish, not hiking and sounding very dovish while expressing concern about the global economy may be the worst thing that could have happened today.

We have been saying for months that the global economy is weak and the Fed’s dovish disposition today only bolsters our view. Europe is about to enter QE2 as inflation and growth remains poor. Japan and Brazil were just downgraded. Commodities remain   under pressure and we think, at some point, the narrative could turn from a supply driven story to a demand driven one. Domestically it becomes harder to argue that a strong dollar and the lack of inflation can be viewed as transitory and this headwind is continuing to hurt high yield corporates. Manufacturing is uneven, consumer spending hasn’t improved in a year, and 2014 real median income was down 6.5% versus 8 years ago (and down 7.2% from the 1999 level). Although auto sales remain strong, we would expect as much given low gas prices, an aging fleet and the fact that auto loans are one of the few places in the economy where it’s easy to obtain credit.

Additionally, high yield corporate earnings remain incredibly weak, with yoy earnings growth negative for the first time since the recession (even ex: commodities EBITDA growth is only slightly positive). Leverage is at all-time highs (again, even ex- commodities) and the High Yield index is more globally exposed than it has ever been (35% of the market generates 45% of its revenue from outside of the United States, and that doesn’t include Energy, which is globally exposed despite not realizing significant direct sales abroad).

Not only are earnings weak, but there has been next to no capex investment, debt issuance has been massive, and buybacks and dividends have driven equity valuations as CEOs and CFOs, afraid to invest in organic growth, have chosen to buy growth instead. And as a result, recovery rates are 10-15ppt below historical norms and defaults and downgrades are creeping into the market. Although we understand many will say its just commodities, is it really? What started as coal weakness 18 months ago became coal and energy weakness. But it wasn’t really just the commodity sectors, as retail was also already weak. Now it’s the commodity sectors, retail and wireline (but definitely not all of telecom). The situation almost seems unbelieveable, as everything that seems to go wrong is explained as being isolated (AMD, well, of course semiconductors are in a secular decline) and treated as a surprise (Sprint).

In our view, the makings are there for a risk off environment for some time to come. For non-commodity spreads to be 400bp tighter than in 2011 makes little sense to us. Replace Greece for a much bigger problem: China. Replace Washington dysfunction and debt downgrade with uncertainty about monetary policy and EM weakness (though we may see Washington dysfunction very soon between this fall’s budget talks and the presidential race looming). Replace US QE with European QE. Additionally, replace   strong earnings growth and margin expansion in 2011 with no earnings growth, a stronger dollar, and higher leverage today. Replace decent liquidity back then with poor liquidity now. And replace the fears of a double dip recession with the potential for fears of a global recession. Though this last point has yet to play out, we think it’s only a matter of time before investors begin to feel as bearish as we do.

The Fed had an opportunity today to hike rates and begin to build a cushion should the global slowdown be so severe it can’t be ignored. Instead, they chose to wait. In our view, this has left them in a predicament as now the rumbles of never being able to increase rates will become even more exaggerated, and when they ultimately do, we think it will be more painful than if they had gone today. We expect as a consequence for there to be more market volatility, more uncertainty around the Fed’s motives and belief in the economy, and therefore more downside risk. Most importantly, however, the acknowledgment of weakness only bolsters our view that we are in the midst of the beginning of the end of this credit cycle, and we warn investors to tread carefully not try to be a hero into year end.

Now is the time that investors need to be managing risk rather than looking for alpha. 1 or 2 names will destroy the performance for what has otherwise been a good set of holdings. Remember what many have forgotten over the last 7 years, credit returns are skewed to the downside. The best case scenario is to earn coupon and the ultimate payment of principle. The worst case scenario is 40, 50, 60 or more points of loss.

We’re in the midst of watching a slow-moving train wreck, and in our view the Fed confirmed as much today.

Sat, 09/19/2015 - 20:25 | 6570229 Farmer Joe in B...
Farmer Joe in Brooklyn's picture

Too long and too "Merrill-y"...didn't read.

One note: It will NOT be a slow-motion train wreck. 

This bitch is gonna start picking up steam.

Tick tock, motherfuckers...tick tock....

Sun, 09/20/2015 - 05:50 | 6570904 ElectroGravitic
ElectroGravitic's picture

The Fed will use NIRP for the next downturn.

Not off topic, and more importantly:

https://youtu.be/0gVLv5eg4Xg?t=5093

 

Sat, 09/19/2015 - 17:57 | 6569953 Multivariate Man
Multivariate Man's picture

No one answered my question earlier today.  PLEASE, can someone explain how VIX drives the S&P 500, why does shorting VIX cause a rise in the S&P?  What is the linkage mechanism?  I can certainly see that it occurs, but what's the mechanism? 

Sat, 09/19/2015 - 22:23 | 6570475 Bucket Boy
Bucket Boy's picture

There is a forward implied price distribution of the underlying based on option pricing. Looks more like a Tracy-Widom type than a Guassian. Seems like a powerful wizard behind the curtain could tease the whole market in a certain direction by using options (VIX) and futures to imply an unnatural forward price.

Sat, 09/19/2015 - 20:11 | 6570214 Monetas
Monetas's picture

MOACAL .... Mother of all class action lawsuits .... remedies for those who lost, penalties for those who won and compensation for those who were dissuaded from investing ?

Sun, 09/20/2015 - 01:44 | 6570768 Clowns on Acid
Clowns on Acid's picture

What is a English Bolshevik doing at the helm of the Fed's Trading desk ? Another question for Hilsenrath to ask Janet... or Murdoch firstly

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