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Guest Post: How To Manipulate VIX Settlement Price

Tyler Durden's picture


Submitted by OnlyVIX: Volatility Futures and Options

How To Manipulate VIX Settlement Price

VIX expiration day often coincides with particularly heavy trading activity in underlying SPX options. VIX settlement value, or VRO rarely matches either the Tuesday close or Wednesday open prices on the "cash" index, prompting pundits to blame VIX settlment for being manipulated. A popular theory is that VIX settlement value is being pushed up or down with huge SPX trades, referred to as "carpet-bombing". Some say that the manipulative trades are concentrated around high-vega strikes, others concerned specifically about puts. In this post I explain why large trades are not likely an explanation for VIX manipulation, and instead how VIX settlement value can be artificially increased for less than one hundred dollars, how VSTOXX futures and options are not subject to such manipulation, and propose a simple modification that makes VIX manipulation too expensive to be profitable.

VIX settlement value is determined by a Special Opening Quotation, based on the opening trades of SPX options instead of quotes. It is true that VIX settlement value can be made higher or lower by placing a big order that would result in a trade. The quantity necessary to move ATM SPX options is significant, and such trade would have to either be maintained and hedged until expiration, or exited immediately possibly with a large slippage. For this reason I don't think that it would make sense for a trader to attempt to manipulate VIX this way - it is very costly, and possibly very risky if the market moves against the trader, and I believe that heavy trading on the open of VIX expiration does not signify VIX manipulation, but rather legitimate SPX trading activity.

However a different form of VIX manipulation is possible. The VIX calculation formula is a weighted sum of option prices, with weight proportional to 1/K^2, where K is the strike. When K is getting smaller, 1/K^2 is getting bigger. While in theory such growth in a weighting term is mitigated with declining put prices (as K is getting smaller puts get cheaper) in practice it seems possible to "blow up" the VIX by placing orders - nickel bids that are most certainly would get executed - at very low strikes. It is a rather small investment - a few cheap options with limited risk since all options are bought - no short positions.

How this would work in practice:
1. On Tuesday before VIX expiration before the close, a trader purchases a significant amount of VIX calls, ATM or slightly OTM, that have the most potential gain from an unanticipated VIX increase.
2. On Wednesday before the open, a trader places 0.05 1-lot bids on low strikes SPX puts for the next month's expiration (the expiration that determines VIX settlement)

To illustrate the idea I downloaded SPX data from the September 2011 VIX expiration available from the CBOE website here. VIX settled at 33.72, with 550 being the lowest strike traded. As I mentioned above, by construction VIX is very sensitive to the low-strike puts, and if a 500 strike had traded at 0.05 VIX would have settled at about 33.73. If 400 and 500 strikes had traded at 0.05 VIX would have settled at about 33.86; adding a 300 strike trade would push VIX to 34.06; adding a 200 strike trade would push VIX to 34.50; adding a 100 strike trade would push VIX to 36.23. To summarize, for a total cost of 5*$5 = $25 a trader can artificially inflate VIX value by 2.51 points.

500 +0.01
400 +0.14
300 +0.34
200 +0.78
100 +2.51

This methodology applies to any VIX expiration. Using settlement data from August 2011 expiration I estimate potential effects of price manipulations as above.

500 +0.15
400 +0.26
300 +0.47
200 +0.92
100 +2.69

Since the CBOE provides what they call "likely VIX series" we can know which SPX strikes were available at the time of expiration, and calculate exactly the effect on VIX index for every expiration for which data is available. The greatest effect on VIX comes from the lowest strike, so for practical implementation the strategy would depend on which SPX strikes are listed.

Economic significance of such manipulation depends on VIX options on the last trading day, and opening price of SPX. Historically the overnight VIX move from Tuesday close to Wednesday morning settlement has been rather volatile (Russell Rhoads did a study of this in his book), but I believe in most cases the trade would have a very large upside with limited downside.

VSTOXX - a pan-European volatility index based on EURO STOXX 50 index is not subject to such manipulation. The contract is settled into an average of index values during a half hour period on the last trading day (here)

The Final Settlement Price is established by Eurex on the Final Settlement Day, based on the average of the index values of the underlying on the Last Trading Day between 11:30 and 12:00 CET.

This certainly makes sense given that VSTOXX expires in the PM. However now that SPXPM options are picking up some volume on C2 I think it would make perfect sense to calculate VIX values based on a similar averaging procedure as VSTOXX that makes manipulation very expensive and practically impossible, or the CBOE to offer a different settlement procedure that is more resistant to manipulation.


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Thu, 10/06/2011 - 18:29 | 1747770 swissaustrian
swissaustrian's picture

Great stuff.


Thu, 10/06/2011 - 18:33 | 1747779 Motley Fool
Motley Fool's picture

We shall set up a committee to investigate this matter for the next few years and definitely make a ruling to put an end to this ...soon.

Thu, 10/06/2011 - 19:05 | 1747879 Aeonios
Aeonios's picture

Scratch that, first we need to talk about planning to set up an investigation committee, and then we can agree on a plan to address this issue over the next few years. We expect that everyone will show the necessary political will and uphold the spirit of bipartisan cooperation in dealing with such challenging issues in the future.

Thu, 10/06/2011 - 19:21 | 1747925 Motley Fool
Motley Fool's picture

I must nominate you to assist on this planning comittee as your expertise in these matters is made clear by your elequent illustration of the true underlying problems and the path we must forge towards a collective solution.

Thu, 10/06/2011 - 19:37 | 1747960 Fazzie
Fazzie's picture

Can we sill surf for tranny porn?

Thu, 10/06/2011 - 21:33 | 1748205 LongSoupLine
LongSoupLine's picture

Well, I propose prior to any of this, we appoint a "planning investivative committee Tzar".  The Tzar will require a staff of 50-100 Harvard quant graduates broken into 3-4 sub-teams, each lead by a former Goldman prop desk expert.  The goal is to provide clear and concise reporting (in triplicate of course) as to the impact of such operations and strategies on the overall reelectability of the POTUS.  (Secondary data quantifing impacts to taxpayers and unfair advantages/balances in capital markets may be submitted if time allows.)

Thu, 10/06/2011 - 23:28 | 1748299 DeadFred
DeadFred's picture

Forget the committees, I HAVE VIX options so I want the rest of you to buy some and on the last day pitch in $25 for the common good. If 1% of ZHers did this...

Thu, 10/06/2011 - 18:40 | 1747806 FOC 1183
FOC 1183's picture

This is great work and quite plausible.

Thu, 10/06/2011 - 18:44 | 1747824 Racer
Racer's picture

So Turnaround Tuesday...

Thu, 10/06/2011 - 18:51 | 1747830 mynhair
mynhair's picture

Vega?  WTF?  I'm going to drink more.   Delta was a bitch, now Vega? 

You people make this shit up just to impress yourselves?

Nice way to collapse the system; invent shit.

You klowns are like lawyers in that respect.

Thu, 10/06/2011 - 20:22 | 1748056 Central Bankster
Central Bankster's picture

Its really not that complicated.

Thu, 10/06/2011 - 20:27 | 1748064 disabledvet
disabledvet's picture

It is scary to think that it could be true. Of course "how is one to know whether an irrational pessimism has taken hold?"'s one way: when the "bullshitski indicator" is "all red all the time." HONESTY...through...DISCLOSURE...never hurts. Unless of course "we actually love Goldman Sachs here too and trade against our clients all the time here, too." Unless of course we're not considered...clients. Now let's get back to our regular "programming" of "wtf is going on in Europe" shall we?

Thu, 10/06/2011 - 21:37 | 1748215 LongSoupLine
LongSoupLine's picture

I dunno...anything with Greek terms seems like a bad idea these days.

Thu, 10/06/2011 - 20:08 | 1748026 swissaustrian
swissaustrian's picture

as you pointed out, the cycles for silver aren´t as clear as they´re for gold. I expect silver to retest 26, at least.

Thu, 10/06/2011 - 18:59 | 1747864 Schmuck Raker
Schmuck Raker's picture

Can somebody loan me $100?

Fri, 10/07/2011 - 08:04 | 1749027 Hephasteus
Hephasteus's picture

Learn how to be self sufficent like a banker. Print your own 100 bucks.

Thu, 10/06/2011 - 19:02 | 1747871 oh_bama
oh_bama's picture

I am not a VIX trader but I would like any expert to help me out:

What prevent me from doing this:

0: Buy some 5 cents puts a few days before the expiration tuesday/wednesday, 10000x or whatever amount.

1: Selling the ATM VIX call spread 10000x (The reverse trade of the step 1 above)

2: Puting 2 cents offers (Quote) on all puts below the 5 cents put strikes so they will never trade 5c.

I make money either from the ATM VIX call spread, or, if someone buys a lot of 5 cents options, gain something from the put skew.

Please help



Thu, 10/06/2011 - 22:05 | 1748283 fzerohedge
fzerohedge's picture

Couple of issues.
1- transaction costs.. Think about what the bid ask is to trading baby puts.. The vix futures and variance swaps trade not because they are every
hedged every time with a strip of spx options, but because they are a useful volatility hedge. You are paying to enter a trade not only on multiple spx options but also on a vix call spread.
2- steps 0 and 1 are not the opposite by any means. Step 0 involvles being long vega, but depending on how far down in strike you are invokes some net delta and gamma which needs to be hedged as well. Step 1 is a more pure vol bet.

Trade could easily lose. You set up the trade and spot rallies 3% overnight. Vol falls, your call spread loses money and no one bids for your puts.

Fri, 10/07/2011 - 08:16 | 1749048 oh_bama
oh_bama's picture

Thanks for your insightful and very helpful explaination. tell me how my call spread lose money if vol falls? I sold call spread.



Thu, 10/06/2011 - 19:03 | 1747873 Schmuck Raker
Schmuck Raker's picture

Oops. Never mind.

I couldn't understand a word beyond that first paragraph. :)

Thu, 10/06/2011 - 19:10 | 1747890 mynhair
mynhair's picture

You need to get in touch with your inner Vega.....

bet this klown is in NYC, and is a Vegan...

Thu, 10/06/2011 - 19:20 | 1747922 SilverIsKing
SilverIsKing's picture

Trade idea:



1. Limited downside given SNB peg of 1.20-1.25 EUR with current price at 1.235.

2. SNB will be forced to de-peg, timing unknown.

3. Potential upside of 20% of more.


1. SNB keeps peg indefinitely

2. SNB raises peg


Thu, 10/06/2011 - 20:03 | 1748019 swissaustrian
swissaustrian's picture

THey didn´t burn as much money as many thought to keep the peg, so they have a lot of firepower left.

I actually went long at 1:1 and dumped my calls at 1.21 on the day they announced the peg.

I see were you´re coming from, but if I were you, I´d wait a little bit longer. Your puts will just loose time value if you buy them too early...

Thu, 10/06/2011 - 20:28 | 1748069 SilverIsKing
SilverIsKing's picture

I wouldn't do this with options unless it got to an extreme due to a particular event and then perhaps I'd play for a snap back.

I am considering taking a forex position, short EURCHF, and just holding until the inevitable happens.

Thu, 10/06/2011 - 20:01 | 1748012 New_Meat
New_Meat's picture

Maximum Pain-Bitchez!

Thu, 10/06/2011 - 20:10 | 1748030 slewie the pi-rat
slewie the pi-rat's picture

"...propose a simple modification that makes VIX manipulation too expensive to be profitable."

now, that sounds dangerous!

Fri, 10/07/2011 - 08:09 | 1749040 Hephasteus
Hephasteus's picture

You're never going to graduate from Con Artist University with that attitude mister.

Thu, 10/06/2011 - 21:03 | 1748147 jdrose1985
jdrose1985's picture

It was just MHFT covering his VIX puts

Thu, 10/06/2011 - 21:04 | 1748148 jdrose1985
jdrose1985's picture


Thu, 10/06/2011 - 21:08 | 1748159 bob_dabolina
bob_dabolina's picture

Pop quiz, hotshot. There's a bomb on a bus. Once the bus goes 50 miles an hour, the bomb is armed. If it drops below 50, it blows up. What do you do? What do you do? 

Thu, 10/06/2011 - 23:29 | 1748518 SilverIsKing
SilverIsKing's picture

I would take a cab.

Thu, 10/06/2011 - 22:00 | 1748272 Cat On A Ledge
Cat On A Ledge's picture

Simply extend the scope to average closings for the last trading week. Vix is cash-settled after expiration isn't it? That'll work.

Wed, 10/12/2011 - 10:06 | 1765446 karmete
karmete's picture

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