Lots of Things Can Look Like Manipulation

But someone can find out for sure.

This post originally appeared in Money Stuff.

There's a classic form of market manipulation where you own a derivative on, say, gold, and it pays out 1,000 times the price of gold at a particular time, and you go into the market and buy 100 ounces of gold at that particular time to push the price up, and if you overpay for the gold by $5 and it pushes the price up by $5, then you lose $500 on your gold and make $5,000 on your derivative, and so it is worth it, but it is generally considered to be cheating, when you put it like this.

On the other hand there are other things that are not cheating that look a lot like this. If your derivative is expiring at the particular time, and you want to continue to have exposure to gold after the derivative expires, you might decide to buy gold right at the expiration time in order to maintain your exposure, which might push up the price of the derivative at settlement. If your derivative is an option, then your model might require you to dynamically hedge it, which might require you to buy a lot of gold right near the expiration time. Or, you know, right around the expiration time, you might get a random hankering to buy gold. No one could prove you didn't, right?

The CBOE Volatility Index -- the VIX -- is a thing on which there are derivatives (notably, VIX futures), except that instead of being a particular thing it is a mathematical combination of options on the S&P 500 Index. This makes the discussion above more complicated and less transparent: Depending on the circumstances, buying a lot of one S&P 500 option right at the time that VIX futures expire could easily move up the price of the futures enough to make your losses on the option worth it. And you occasionally see claims that that happens; we have talked about them before.

Here's the latest, from yesterday:

The VIX, which derives its price from S&P 500 options, was sailing along without incident until about 9 a.m. in New York, when it spiked as much as 11 percent in about an hour’s time. The jump coincided with a Cboe auction in which a monthly settlement value is set for the gauge, one that is critical to owners of some of the most popular futures in the country. ...

Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors, saw evidence the VIX was pushed higher intentionally. Among other things, roughly $2.1 million was spent in the runup to the settlement on “extremely irrelevant” options that were tied to a 50 percent drop in the S&P 500.

If you paid $2.1 million for those options and they turn out to be worthless, but you owned $20 million or so worth of VIX futures that expired yesterday, then that could have been a good manipulation trade. "These far downside options have a disproportionately large effect on the VIX settlement," points out Chintawongvanich in a client note.

Or it could have been something else, whatever:

“You can always find people that argue that this is just a normal thing to happen -- market makers need to unload their inventory, and they happened to have too many far downside options this time around,” Chintawongvanich said. “These are all legitimate explanations. We’ll probably never know who did it.”

Well! I am not sure I quite share that fatalism. It is correct in a narrow sense, which is that it is quite difficult for you or me or Chintawongvanich to infer manipulative intent from trading activity. The buyer of those options could have been a long futures speculator trying (successfully) to push up the price of his futures, or a futures trader trying to roll her exposure into the underlying, or a doomsayer genuinely betting on a massive near-term drop in stock prices, or someone who meant to spend $21,000 on S&P 500 puts and pushed the wrong button, or someone pursuing a fiendishly complicated multi-leg strategy in a dozen different markets that happened to have touched mysteriously on the S&P 500 options market at a critical time yesterday. 

But it does look weird, and someone could find out more about it. CBOE, the exchange where the VIX futures are traded, or the Commodity Futures Trading Commission, which regulates it, could find out who bought those options and send them a polite note asking what was up. They could perhaps examine some emails and chats, maybe do a keyword search for words like "manipulate" or "bang" or "gun" or "hahaha they'll never catch me" or misspellings thereof. Manipulation is fundamentally an issue of intent, and the way you prove intent is by (1) noticing unusual trading and then (2) finding the dumb chat where a trader says "I intend to manipulate, hope it works!" 

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