A recent paper by two researchers at the University of Texas has found evidence that the VIX settlement is being manipulated via the trading of SPX options. John Griffin and Amin Shams note that "price and volume patterns at settlement" are "consistent" with attempts to manipulate the VIX. They argue that this is a potentially attractive trade because of the difference in liquidity between SPX options and VIX-linked products such as futures. A relatively small investment in moving the prices of SPX options can lead to a much larger payoff in VIX-linked products. The paper estimates that between 2008 and April 2015 the average "settlement price distortion" is "1.5% of the VIX settlement value" (around 0.17 volatility points with the VIX at 11).
The arguments presented by the authors are that "volume spikes occur only at the time of VIX settlement, [and] only in the options used to calculate the VIX", "not in SPY options" and that the trading is "proportional to the sensitivity of VIX to each strike price with a jump [in volume] for options that have a discontinuously higher weight in the VIX calculation".
The authors also examined the European equivalent of the VIX, the VSTOXX. They exposed that it, too, "exhibits patterns strongly indicative of gaming the settlement," even though the product was "designed with an eye to mitigate the impact of temporary price pressure [at settlement]". In particular, the paper finds that trading in options used in the VSTOXX settlement calculation "increases to around 130 times of that in the rest of the day, whereas the options below this threshold experience minimal trading activity". It also discovered that "trades cluster consistently exactly at five-second intervals throughout the settlement period". That is exactly at the time that the VSTOXX is calculated, rather than continuously. This provides some support for the argument that the trading is manipulative rather than bona fide hedging activity.
For the full paper, please click here.