Yesterday, for the umpteenth time in the last few years, we exposed the clear manipulation of VIX at the futures settlement auction - spiking VIX to favor the record long positioning of VIX futures speculators.
With stocks quietly drifting sideways ahead of the US cash open this morning, VIX suddenly spiked reprising a pattern of jerky moves on days when futures on the gauge are settled in monthly auctions...
As a reminder, VIX futures settle on Wednesdays at 9:20 a.m. New York time in an auction by Cboe Global Markets.
As Bloomberg notes, VIX was heading for its longest streak of daily losses in almost a year in early New York trading, before it reversed direction and rose as much as 11 percent.
The gain occurred around the time of the settlement, which happened 13 percent above the VIX close on Tuesday and outside of today’s range.
Both the settlement price and the high-water mark for the VIX occurred more than 10 percent above Tuesday’s close -- lucky, if you were betting on a gain.
And as VIX was manipulated around the auction, so the option-market 'tail' wagged the broad-stock-market 'dog' - slamming the S&P down almost 20 points.
And don't forget, large speculators hold a record net-long VIX futures positions, according to the latest data from CFTC...
So this settlement spike was very much in favor of all those speculators - after a week of crushing them - how convenient.
So just how easy is it to do this?
How do 'traders' manipulate the options market, thus moving VIX in their favor, to rig stock momentum one way or another?
Bloomberg reports that Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors, says the VIX - a gauge of the implied volatility of the S&P 500 Index derived from out-of-the-money options - was 'gunned'.
That is, it was intentionally pushed higher.
A massive bid for protection against a tumble in equities caused the prices of put options to soar in early trading on Wednesday, effectively forcing up the official settlement level for VIX.
“Around 9:15, suddenly a bid emerged for the extremely far downside options, pushing the early indication [of the VIX] up 1 point," Chintawongvanich said.
“By 9:30, the early indication was around 17.50, up over 2 points from the 9:00 a.m. level, despite S&P futures remaining unchanged."
Bloomberg's Dani Burger highlights some of the S&P 500 options that were at the center of yesterday's VIX rigging speculation.
One trade of 13.9k May puts with a 1200 strike during the VIX settlement (at a total cost of $348,000).
Tied to options that gain on a 50% SPX decline... and before Wednesday, the five-session average volume for this option was just 22!
Roughly $2.1 million was spent bidding up put options with strike prices that had 50 percent downside from current levels, the strategist calculates.
To visualize this manipulation better... here is a chart of the premium traded in the April VIX settlement, by strike...
And compare that to March VIX settlement...
So, to summarize: with speculators the longest volatility they have ever been - and facing some very recent pain from 5 days of volatility declines - the settlement level for April was manipulated over 2 vol points higher - potentially saving the 92,913 long vol futures contracts' traders millions of dollars (among others)... at a cost of just $2 million - buying deep, cheap OTM Puts to push up the skew (the outside volatility) and thus drive up VIX (which is calculated from a strip of OTM options).
Further still, as VIX was monkey-hammered higher, so the reflexive - albeit slightly delayed - reaction in the stock market was a 20 point drop in the S&P 500 (120 point drop in The Dow), which could have garnered dramatic profits for anyone who was algorithmically buying the deep OTM Puts and sell equity futures simultaneously.
Still think stocks are all about fundamentals?
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Of course, as Bloomberg reports, Cboe Global Markets declined to comment.
Last month, Cboe CEO Ed Tilly said at a conference that “the integrity of our VIX products and markets is paramount. And, if our regulatory team were to uncover any manipulation, it would be rooted out, swiftly and decisively. Period.”
But, as Reuters reports, France's market watchdog did make a statement this morning with regard manipulation of European equity volatility markets, claiming it was "very unlikely."
Any manipulation of Europe's main gauge of stocks volatility would be "very unlikely", France's financial markets regulator said in a research note on Thursday, following allegations that the equivalent U.S. "fear gauge" was being manipulated.
Europe's VSTOXX, the region's equivalent to the U.S. CBOE S&P 500 volatility index VIX, would probably be protected from any possible rigging due to the different method used to settle prices for the VSTOXX futures, the Autorité des Marchés Financiers (AMF) said.
"As the index is calculated every 15 seconds, 61 points are used in calculating the settlement price of the future (as opposed to a single point for the VIX). Given the liquidity of Eurostoxx 50 options at this time of the day, it would thus appear much more difficult and costly to manipulate VSTOXX futures," the report said.
The AMF also ruled out the possibility of manipulation of France's volatility index, VCAC.
"Since the VCAC is not an underlying of listed derivatives, a manipulation scheme on the VCAC index similar to the alleged VIX manipulation may thus be ruled out," the watchdog said, adding that no products reference the VCAC index.
Translated: It couldn't happen here...