The VIX, its market microstructure and market manipulation

The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is colloquially referred to as the fear index or the fear gauge. The current VIX index value quotes the expected annualized change in the S&P 500 index over the following 30 days, as computed from options-based theory and current options-market data. Despite its theoretical foundation in option price theory, CBOE’s Volatility Index is prone to inadvertent and deliberate errors. Many claims of market manipulation have been brought up against the VIX in recent years. Replicating the VIX index by using empirical options data from CBOE we want to show which one of those claims are justified and lead to meaningful alterations of the VIX. As an example, the market microstructure behind the pricing of VIX derivatives appears to be flawed. Very liquid derivatives are priced off an illiquid auction mechanism of out-of-the-money put and call options. To make matters worse, those derivatives are cash-settled and the settlement value of the VIX, as used for the pricing of its derivatives, is based on a different calculation than the regular VIX index. As a second example, the settlement values can substantially deviate from the previous-day close. Claims of market manipulation related to that are based on a wide-spread misunderstanding of how the settlement values and the VIX index are calculated and that they are not justified in the way that they are brought up in the academic literature at the moment.

Expected outcome:

• A thorough understanding of the VIX market and the underlying options market
• A better understanding of mispricing and characteristics that are prone to market manipulation
• Find new ways how to make the VIX index safer for investors and market participants as well as less prone to manipulation and errors
• Give guidance to the US regulators and the Chicago Board Options Exchange that have been investigating potential market manipulation claims for several years.