How Wall Street’s ‘fear gauge’ is being rigged, according to one whistleblower

Cboe’s VIX products is the target of a whistleblower (Getty Images)

 

One of the most popular measures of volatility is being manipulated, charges one individual who submitted a letter anonymously to the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The letter makes the claim to regulators that fake quotes for the S&P 500 index are skewing levels of the Cboe Volatility Index which reflects bearish and bullish options bets 30-days in the future on the S&P 500 to gauge implied stock-market volatility (see excerpt from the letter below).

The flaw allows trading firms with sophisticated algorithms to move the VIX up or down by simply posting quotes on S&P options and without needing to physically engage in any trading or deploying any capital. This market manipulation has led to multiple billions in profits effectively taken away from institutional and retail investors and cashed in by unethical electronic option market makers.

The whistleblower’s claims are consistent with those documented by John Griffin, professor of finance at the University of Texas and Ph.D. candidate Amin Shams in May 2017 in research that says the cost of manipulating less-liquid SPX options would be more than paid for by a successful bet on the direction of the VIX. The paper is consistent with the whistleblower’s conclusion—that manipulators are moving prices of the SPX options by spoofing at settlement—entering quotes for trades that are never executed—to “paint the tape” and, therefore, influence the value of expiring VIX derivatives.

The VIX has underpinned a number of strategies described as so-called short-volatility, which imploded dramatically last Monday when VIX, also known as Wall Street’s fear gauge, registered its largest percentage change in its history, cratering bets that volatility measures would fall, if not remain muted.

The spectacularly wrongway short bets had become one of the most popular trades on Wall Street because volatility had gone eerily absent for a protracted period, encouraging investors, who were lamenting the narrow trading ranges present during that period of placidity, to make more aggressive wagers to generate richer returns. Those moves also came amid ultralow rates for government bonds, particularly the 10-year Treasury note TMUBMUSD10Y, -0.82%

Jason Zuckerman, attorney at law firm, Zuckerman Law, who is representing the anonymous whistleblower, told MarketWatch that his client is concerned about unfair markets.

“My client is concerned about VIX manipulation that has already caused investors to incur massive losses and is eager to prevent further harm from investors,” Zuckerman said.

The whistleblower would also like the market regulates to play a more active role in preventing further harm to investors including requiring more accurate and comprehensive disclosures about the various risks that are associated with products linked to VIX,” he said.

The letter urges “the SEC and CFTC to promptly investigate the matter before investors suffer additional losses due to this fraud.”

Full article: How Wall Street’s ‘fear gauge’ is being rigged, according to one whistleblower (MarketWatch)

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