Does the VIX Need Fixing? Sure Looks That Way

Last week, the Chicago Board Options Exchange (CBOE) responded to a research report into manipulation of the monthly settlement of the VIX, sometimes referred to as the stock market’s fear index, and attempted to assure participants that the process was not rigged. “The academic paper’s analysis and conclusions are based upon a fundamental misunderstanding about how VIX derivatives are traded and settled,” the CBOE wrote. I was an author of the research paper. The CBOE’s most recent response has left my "fundamental misunderstanding" still very much unresolved.

Here is the process at issue: At 8:30 a.m. central time on the third Wednesday of each month, the VIX calculation — which is otherwise continuously updated — is used to determine the value of billions of dollars worth of VIX derivatives. This is the monthly VIX settlement. If a manipulator with a large VIX derivatives position could nudge the lower-level Standard & Poor’s 500 Index options that underlie the VIX for just a brief period, the profit potential would be vast. And this appears to be happening. We have noted regular and increasing deviations between the settlement price and the open price, which is calculated just seconds later. Just this month, the deviation in that split second was more than 12 percent, distorting the derivatives market by more than $200 million. Indeed, since the public release and publication of our academic paper last year, the settlement deviations have substantially increased. We are concerned that market participants may be reading our paper as a how-to-manipulate manual.