Posted by Chuck Reynolds on May 24, 2017 - 4:48pm

VIX Trading, Hoaxes and Blockchain

Also oil data, executive business education, fat unicorns and bond market liquidity.


VIX manipulation!?

The CBOE Volatility Index -- the VIX -- is a measure of expected volatility in the S&P 500 index. People pay more for options when they expect prices to be volatile, and you can compute implied volatility from option prices. So the VIX looks at the trading prices of a bunch of out-of-the-money put and call options on the S&P 500 and computes a sort of average implied volatility from them. The methodology is in this white paper.

In addition to being an index that is much quoted in articles about market complacency, the VIX is used as a reference price for derivatives: If you want to bet that stock-market volatility will go up, or down, you can buy or sell futures or options on the VIX. These products are cash settled: The VIX is not a thing you can own, so if your option ends up in the money you just get paid cash for the value of the VIX at settlement. CBOE gets an official settlement level of the VIX based on a special monthly settlement auction of S&P 500 options. The auction runs from 7:30 a.m to 8:30 a.m., Chicago time. Traders submit bids and offers for S&P 500 options, the auction matches buyers and sellers to find clearing prices, and the prices of those S&P 500 options are used to compute the official settlement level of the VIX.

Guess what?

At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in out-of-the-money options that are used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of hedging and coordinated liquidity trading. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure in Europe are inconsistent with these explanations but consistent with market manipulation.

That's from this paper by John Griffin and Amin Shams of the University of Texas, who find a lot of trading in the S&P 500 options underlying the VIX during these settlement auctions, trading that pushes the settlement price of the VIX up or down. So for instance in months where the trading pushes the VIX up, the prevailing price of the VIX-influencing options will jump during the auction, peak at around 8:15 a.m. (the deadline for VIX-related bids in the auction), and then drop seconds after the auction ends when

The options start trading normally:


The blue line there is a measure of the indicative prices

of VIX-influencing options, spiking at 8:00 a.m. and peaking near 8:15. (If you ignore the numbers on the axis, you can almost think of it as being a chart of the VIX price.) The red dot is the trading price of those options about 25 seconds after the auction finishes. The average effect is something like 0.31 VIX points, sometimes up and sometimes down, depending on the month. 

What is going on? Usually when you see patterns like this, the innocent explanation is hedging. But Griffin and Shams consider and reject that notion here, noting for instance that traders don't seem to be closing out existing hedge positions but instead adding new ones. They argue that it's more likely to be explained by attempts to move the VIX: If you are a dealer who is long (short) VIX futures, you can push up (down) the VIX at settlement by buying (selling) some deep-out-of-the-money S&P 500 options. That is generically true in any derivatives market: If you are long a derivative, you can buy the underlying and push up the derivative price. But Griffin and Shams give a list of reasons why you'd almost expect the VIX to be manipulated:

First, the upper-level VIX market is large and liquid, enabling a trader to invest a sizeable position in VIX derivatives. In contrast, many of the lower-level SPX options, where the VIX values are derived from, are illiquid.

Griffin and Shams calculate that "the size of VIX futures with open interest at settlement is on average 5.7 times the size SPX options traded at settlement, and it is 7.3 times for VIX options that are in-the-money at settlement." So if you are a trader who owns a lot of the market in VIX futures, you could push around a large dollar value of futures by trading a small dollar value in options. This is particularly true because the S&P option volume is divided among many strikes, and the illiquid deep out-of-the-money S&P 500 options have a big influence on the VIX: You can move the price of those options a lot with relatively small trades, and those price changes have a disproportionate effect on the VIX.

Second, the VIX derivatives are cash settled. Therefore, if the VIX settlement value deviates from its true value, the VIX position will automatically be cashed out at the deviated price.

If cattle are trading at the wrong price when your cattle futures settle, that doesn't matter so much, because you just get the cattle. But you can't just get the VIX: You get cash, so if the VIX is at the wrong price at settlement, that's the price you get.

Third, the settlement occurs within a short period of time based on the SPX options pre-open auction.

You don't have to intervene over some long period to keep options prices up; you can just submit bids in the pre-opening auction once a month and move the settlement price for that month. There is a sort of hierarchy of manipulability in markets. At the top is Libor manipulation: Trillions of dollars of derivatives settled based on Libor, but Libor was calculated by essentially asking banks "what should Libor be?" The banks didn't even have to do any trading in order to push the number around; manipulation was, in effect, costless. (Later, with the fines, it was costly.)

At the bottom is, like, manipulating the price of a stock by trading that stock. There are cases of it! It's a thing. But it is a dumb thing; it really shouldn't work. If you buy a stock, you will push the price up, sure. But to make any money you then have to sell the stock, which should push the price right back down. 

But if you are going to manipulate a tradable market -- as opposed to a made-up one like Libor -- then VIX looks pretty tempting. The product that you trade (S&P 500 options) is different from the product where you make your money (VIX futures and options), and the trading market is in the relevant sense smaller than the derivative market: You can move a lot of value in VIX products by trading a small amount of value, in a confined period of time, in the underlying market. So you can cheerfully lose money executing the manipulation -- trading the S&P options -- and make back more in the derivative. 

If Griffin and Shams are right that there's manipulation, there's no particular pattern to it: Sometimes VIX gets anomalously pushed up during the settlement, sometimes down. That's consistent with, for instance, a story of big dealers adding up their positions before each monthly settlement, realizing that they're net long (short), and trying to push VIX up (down) to help out their positions. It would be like the kind of Libor manipulation that banks did to help out their trading books (which was up or down depending on their positions) -- not the kind of Libor manipulation that banks also did to disguise their funding costs (which moved Libor systematically down). VIX manipulation, if it exists, probably doesn't add to or subtract from the market's sense of complacency. It just makes someone money.

The email hoaxer strikes again.

The guy who previously emailed Barclays PLC Chief Executive Officer Jes Staley pretending to be Barclays Chairman John McFarlane, eliciting polite bafflement from Staley, has now emailed Bank of England Governor Mark Carney pretending to be Anthony Habgood (the chairman of the bank's Court of Directors), and elicited polite bafflement from Carney. Carney was a bit tougher on his pretend-chairman than Staley was:

Carney responded twice before a comment from the fake account about “dashing bar ladies” at the event prompted the quick rebuttal of “Sorry Anthony. Not appropriate at all.” He did not reply to a two further emails from the hoaxer.

Good for him. I have to say that Staley and Carney come off great in these hoaxes. They are perfect models of how to respond to inappropriate emails from your boss: Refuse to take the bait, try to smoothly shift the conversation into less awkward lines, but if he persists, be firm but respectful in shutting him down. Eventually the hoaxer will email a sexist joke to a bank CEO who'll reply "ha ha haha good one, also I killed a man last night," but so far the bankers are 2 for 2 on probity and tact.

Blockchain blockchain blockchain.

The Consensus 2017 blockchain conference is going on now, and Fidelity Investments Chief Executive Officer Abigail Johnson gave a speech endorsing bitcoin and blockchain technology, "a rare vote of confidence by a major player in the financial world."

“It’s no accident that I’m one of the few standing before you today from a large financial services company that hasn’t given up on digital currencies,” she said. “I am still a believer.”

Ehh I can't go an hour without getting a press release about some big bank joining, or starting, some blockchain consortium. Citigroup is a top sponsor of Consensus. I think it is fair to say that votes of confidence, or at least expressions of interest, from large financial services companies are pretty common, though that interest is mainly in blockchain technology, not bitcoin or other digital currencies.

Like the other big players interested in blockchain, Johnson acknowledged problems with current efforts. “Too often we see bitcoin and blockchain technologies as solutions in search of a problem,” said Johnson, whose firm has "enabled bitcoin payments in its cafeteria." "How can we buy lunch," Fidelity employees wondered for years. Committees were set up to study the problem; solutions were tried and rejected; nothing worked. The employees were starving. And then one day, necessity being the mother of invention, someone proposed using bitcoin to solve this pressing problem. It was a perfect fit! Fidelity employees all have a lot of bitcoins, and bitcoins are an incredibly convenient way to pay for a sandwich.

Hahaha no. Don't you think the actual story was that someone at Fidelity was like "what on earth can we do with bitcoin," and someone else was like "uhh I guess we could accept it in the cafeteria"? Even if you think that blockchain is often a solution in search of a problem, you can't help searching for some problems for it. "Fewer than 100 employees at the firm have completed bitcoin transactions, she said." Elsewhere, Allison Schrager asks: "Should you seriously consider bitcoin for your retirement savings?"

Oil data.

Here's a story about services that track oil-market data, including one that "aims to use computer algorithms to analyze satellite imagery, financial data and social news." But the real fun is in the lower-tech services:

Mr. Madani then started crunching oil data from publicly available sources like free tanker-tracking websites and government statistics. Mr. Madani used a shared Google spreadsheet to publish his findings, and that later grew into, a free oil-data website. He says he doesn’t plan to charge a subscription as his website is aimed at independent traders who often can’t afford professional services. “We’re looking after the average Joe & Jane,” said Mr. Madani who routinely stays up until 2 a.m. trying to estimate OPEC members’ compliance with the group’s deal to cut production. “We’re all news and data junkies.”

Isn't that charming? Professional oil traders pay for professional data services that provide them with professional data. (Satellites, etc.) Amateur oil traders get free data services that provide them with Google spreadsheets. You might quite reasonably say, look, there is no way for these hobbyists to compete with professional traders whose job is to trade oil and who have access to the best data. And yet they keep trying. It's important to realize that not all trading in financial markets is driven by economic considerations. Sometimes people trade because it is fun.

Elsewhere in privileged access to energy information, Carl Icahn's CVR Energy Inc. saved about $60 million by delaying purchases of renewable identification numbers as Icahn was advising Donald Trump to change renewable-fuel rules to make RINs less valuable. 

Executive education.

Here is a Harvard Crimson article about non-degree-granting executive education courses at the Harvard Business School, which includes this lovely bit of intra-Harvard snark

(about Tyra Banks):

Banks, for example, completed the nine-week Owner/President Management program, designed specifically for presidents and CEOs of companies making over $10 million annually. The program’s application doesn’t ask for GMAT scores or GPAs, but does have sections for applicants’ annual incomes and ownership stakes in their companies.

Hahaha it is a little hard for Harvard students to imagine choosing executives for business education based on their business skills rather than their standardized test scores. 

But there is this:

Participants in the program attend one three-week session per year for three years. In 2018, the first session will cost $42,500.

For $14,000 a week, even Harvard can dispense with the GMAT. Elsewhere in graduate business education, here's "Why Stanford MBAs Earn the Most":

At Stanford, which Bloomberg Businessweek ranks as the second best MBA program in the U.S., after Harvard, students are encouraged to pursue their passions rather than settle for traditional gigs. “We have a culture where you are encouraged to do whatever you want, to explore the things you want to do that others may think is crazy,” Pedersen says.

I am skeptical that "pursue your passion" is a good generally applicable way to make a lot of money, but perhaps it works for MBA students. Maybe their passion is money!

People are worried about unicorns.

Here is a Farhad Manjoo article about Opendoor a startup that has raised more than $300 million of equity capital. The article is also about what Manjoo calls "the fat start-up":

Modern capital markets have since unlocked far grander opportunities for tech entrepreneurs. They are blessed with essentially unlimited access to money, and ideas that once seemed too expensive, too risky or just too crazy are now getting off the ground. These start-ups are fat — with capital, with industry-altering ambition and, to their critics, often more than a little hubris.

Private markets are, as I like to say, the new public markets, and it's no sweat now to raise a few hundred million dollars without going public. But if you stay private you can still be a startup: There's less pressure to be profitable, more freedom to pursue ambitious business plans, if you don't answer to public investors.  

One other thing to say about Opendoor is that it is a residential real estate trading firm: It buys houses, and then tries to resell them at a profit. There is technology involved, sure: Opendoor analyzes home-price data on computers rather than sending appraisers out to decide how much homes are worth; "houses it sells are fitted with internet-enabled cameras, sensors and door locks"; there's a website and an app. But the business model is not "we build software and sell it," or "we build websites and sell ads against them." It's "we buy houses and try to resell them at a profit." It's a real estate company. But the imperial ambitions of Silicon Valley mean that it's also a tech startup because, you know, everything is a tech startup, and tech startups are where the money is. You can raise money from technology venture capitalists to sell bags of wet vegetables, or houses: Everything in the world is technology, so tech investors can invest in anything.

Elsewhere in unicorns, the Wall Street Journal visited the Park Slope unicorn store:

The family guided us through the unicorn transformation process. First, we tried on stuffed fabric horns in various sizes and colors, priced from $14 to $30. The original size is better for everyday activities like a spin class, Mr. Bruce advised. The largest size “is better if you’re going to a gala.”

People are worried about bond market liquidity.

The New York Fed's Liberty Street Economics blog is keeping this worry alive with "Dealer Balance Sheets and Corporate Bond Liquidity Provision." "We find that post-crisis regulation has had an adverse impact on bond-level liquidity," the authors conclude, in line with what most bond traders think but somewhat contrary to what most previous Fed and Treasury analyses have found.

Meanwhile, in Greece, bond market liquidity is quite poor:

Only €160 million ($180 million) of Greek government bonds has changed hands on the country’s HDAT electronic-trading platform this year, according to figures from the Bank of Greece. That is a fraction of the levels before Greece ran aground in a decadelong economic crisis. All of the debt traded this year is about as much as was traded in half an hour, on average, from 2001 to 2007.

Food Stuff.

The 21st-century American literary genre with the greatest chance of achieving immortality is Stuff That Food Marketers Say To Reporters. Here's some:

“Every section of the grocery store is fighting for the same food dollar. Same share of stomach. Consumers are smart. I don’t think anyone is going to mistake regular rice for a riced cauliflower product, frozen or fresh.”

Things happen.

A daily take on Wall Street, finance, companies, and stuff.Matt Levine's Money Stuff

China Hit by First Moody's Downgrade Since 1989 on Debt Risk. Trump's Path to a Balanced Budget Paved With Accounting Gimmicks. Glencore Makes Informal Takeover Approach to Bunge. U.S. Sues Fiat Chrysler Over Diesel Emissions. Vanguard's Bogle tells CFA Institute confab indexing-firm concentration concerns him. Target to Pay $18.5 Million to 47 States in Security Breach Settlement. Sears Pushes Back Debt Payments. Blackstone is Taking Over Mom-and-Pop Real-Estate Investing. Insurance: Where Humans Still Rule Over Machines. After Complaints, Fannie Mae Will Stop Selling Homes to Vision Property. Fintech reinvents lottery bonds. Madoff Fund Paid Millions to Breeden Firm, Zero to Victims. Americans Are Taking More Paid Vacation Days. Real estate CEO admits he stole $1.6M to pay for coke and strippers. You Can Have Your Own Social Media Team for Just $25,000 a Month. People are worried about the water fountains at the U.S. Attorney's Office for the Southern District of New York. Dog prom. I'm doing a Reddit "Ask Me Anything" at 2 p.m. today.

Chuck Reynolds
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