Conspiracy "Fact" - VIX Manipulation Runs The Entire Market

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by Tyler Durden
Saturday, Sep 19, 2015 - 18:45

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.

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But there is a silver lining to the recent smashing of fingers trapped trying to pick up pennies in front of 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!!)