VIX Slam

The favorite way to manipulate the stock market these days is the VIX (and/or VXN) slam. There’s one in progress right now as someone doesn’t want the market to go down.

A few years ago the CBOE decided to securitize the VIX – the implied volatility index calculated from option prices. This meant not only VIX futures and options, but even ETFs valued from the VIX.

The VIX is important because it figures in the calculation of fair value for options (Black-Scholes and all that). So when VIX changes, the fair value for many options changes. Now most option writers like to hedge to a delta-neutral position, like bookies who want to balance bets both ways so they are indifferent to the outcome. Obviously, as fair value changes, so do delta and gamma so hedges must be adjusted – called dynamic hedging.

Hedging is typically done by taking long or short positions in the underlying securities, be they stocks or indexes, either directly or by use of futures contracts.

The upshot of all this is that moving the VIX yields enormous leverage to cause automatic buying or selling, as algos adjust hedge positions. Of course, moving the VIX itself is a matter of either directly manipulating the prices of options used to calculate the VIX, or indirectly by manipulating any of the VIX derivatives – futures, options, ETFS, etc.- which in turn result in automatic trades in the said options.

Securitizing the VIX was probably a really, really bad idea as this is an accident waiting to happen. For example, a successful short squeeze in VIX derivatives could easily cause a market crash. It was always possible to take positions in VIX as long-dated, far out-of-the-money put options are an inexpensive, almost pure play on VIX. So the only real effect has been to place another powerful and unnecessary tool in the hands of the market manipulators.

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