Oct 6, 2011

How To Manipulate VIX Settlement Price

Update 12/25/2013: I published a retraction of the post here.

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.


  1. Hi,
    First of all, brilliant analysis.
    I trade VIX futures and while having read about the mechanics, I admittedly never went into depth about how a trader can actively affect the settlement price.

    But like most investment ideas ever published, one has to be skeptical about the nature of its publicity. Have you ever tried and profit from the tactic? If yes (and I hope the answer is yes), did it work out as well as described?

  2. Anonymous10/07/2011

    Not only is this possible, it has been done. The Oct 23, 2008 VIX expiry was accomplished exactly in this manner by Goldman. The CBOE is well aware of this problem. As long as it's Goldman, they don't care.

  3. Interesting analysis its well known that vix expiry can be slightly erm interesting hence quite a few ppl will trade options on VXX and VXZ to mitigate...

    don't rule out large "hedging" trades moving the market...the guys that run the VXX and VXZ have very large books that could absorb and run big trades at odd strikes...they run risk across various buckets and always be short raw vol/var

    Back to your analysis as var swaps are priced off the continum of puts but in practice off a discrete set, odd prices could move the market and the convexity premium we see in NKY can be explained by the market pricing the non existant low strikes higher...or indeed just ascribing a higher price to the actual traded options...which makes sense because experiance has taught the guys out there that when you need to buy the low strikes they get expensive fast if you can buy them at all!...

    one question wouldnt the exchange bust a 5c trade on the 100 strike if the 500 strike also traded at 5c off the same ref...I mean the price for the 100 has to be lower than the 500 so I just wonder if in practice the trades would make it through...perhaps you have already done this analysis maybe I missed it but thats my intial thoughts...nice blog btw.

  4. Anonymous10/07/2011

    one question wouldnt the exchange bust a 5c trade on the 100 strike if the 500 strike also traded at 5c off the same ref.

    The exchange will not bust those trades even if they don't make economic sense. Get the data from the October 2008 VIX options settlement. Many lower priced put strikes traded at higher prices than the higher put strikes. Again, this is Goldman marking the VIX settlement. The CBOE will also arbitrarily adjust the VIX settlement. Again, happened in Oct 2008.

  5. Anonymous10/07/2011

    "the price for the 100 has to be lower than the 500..."... Non-traders often make remarks like this. In fact, a manager with old low-strike option positions might need to clear them off to get an account exactly flat, perhaps so he can redeem the account proceeds or move them to a different broker. If he's short the 100 strike, that's the exact option he has to buy for this purpose, and he has to pay cabinet regardless of economic value.

  6. Anonymous10/10/2011

    Non-traders often make remarks like this.

    Yep, this must be coming from a pro. These options expiry into CASH.

    There is no economic or operational reason as to why someone would pay more for a lower priced strike UNLESS they were marking the VIX close.

  7. Anonymous10/11/2011

    "expiry" is a verb?... In any case, please do reread my comment till you understand what I'm saying.

  8. Only out of the money options with a bid and ask price are used for calculation. So you can't just come as a buyer at an unreasonable price and influence the VIX. You have to be a seller at the same time. And you have to post prices for every strike available or the following aren't included either.

  9. That is not correct MGK - offer will automatically be there because market makers are required to quote options. They can make markets really wide, but the offer will be there. So the only requirement for a strike to participate in VIX calculation is for it to have a bid.

    And yes, you will have to post bids for several consecutive strikes.

  10. Anonymous12/20/2012

    Excellent analysis - after losing quite some money due to unexplainable jump of VIX before Wed open, I am definitely not trading VIX anymore.

  11. Anonymous9/14/2015

    Any update on this issue?

  12. Anonymous2/15/2017

    Does this still hold? ...must be, I guess.
    Does anybody know anything on the regulatory side of this? Are their penalties / did licenses get revoked (or worse) etc.