Manipulation in the VIX?

*
JOHN M. GRIFFIN and AMIN SHAMS

May 23, 2017

Abstract
At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 In-
dex (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 inuence on VIX.
We investigate alternative explanations of hedging and coordinated liquidity trading.
Tests including those utilizing dierences in put and call options, open interest around
the settlement, and a similar volatility contract with an entirely dierent settlement
procedure in Europe are inconsistent with these explanations but consistent with mar-
ket manipulation. Large transient deviations in prices demonstrate the importance of
settlement design.

* Helpfulcomments were received from Hassan Afrouzi, Gurdip Bakshi, Robert Battalio, Shane Corwin,
Martijn Cremers, Andres Donangelo, Michael Johannes, Adam Johnson, Andrew Karolyi, Sam Kruger, Gon-
zalo Maturana, Dmitriy Muravyev, Ehud Ronn, Alessio Saretto, Paul Schultz, Amit Seru, anonymous option
traders, and seminar participants at Florida State University Suntrust Beach Conference, SFS Cavalcade
Conference, the University of Bristol, University of Notre Dame, University of Texas-Austin, University of
Texas-San Antonio, and University of Warwick. Integra FEC and REC LLC purchased data and provided
research assistant support for the project. Grin is an owner of Integra FEC and Integra REC, both of
which engage in nancial consulting on a variety of issues. We thank Chirag Agrawal, Tianjiao Zhu, and
especially Tin Dinh for excellent research assistance. Grin can be reached at john.gri[email protected], and
Shams at [email protected].
Fair and accurate market prices are fundamental building blocks for ecient capital markets.

Yet, market participants have substantial incentives to manipulate these very same nancial

prices on which our economic system relies. Fortunately, market manipulation is quite

dicult. First, if prices move away from fundamentals, other traders have an economic

incentive to trade against such deviations. Second, even if a trader successfully moves the

price away from the fundamental value, it will generally revert back as the trader exits his or

her position. Third, even if a manipulator can impact a security's price and prot from the

manipulation, the expected benet must be greater than the expected penalty costs [Becker

(1968) and Ehrlich (1973)]. Considering these lines of defense, security manipulation should

1
be relatively rare, and this is generally consistent with the evidence in developed markets.

Nevertheless, there has recently been a urry of ostensible manipulation, most notori-

2
ously in LIBOR and FX, but also allegations in gold, silver, and oil. Although the events

have attracted much attention in the press, there has been relatively little empirical aca-

demic research examining specic features of these markets and the mechanisms that allow

for manipulation. One commonly proposed solution to avoid manipulation is to use bench-

mark prices set in the open market. As part of the committee to examine a new LIBOR

benchmarking process, Due and Stein (2015) embrace the use of open market prices, yet

they also note that this may not fully eliminate the potential for manipulation. We examine

such a market in which the benchmark is set through market prices. Following research

by Kumar and Seppi (1992) and Spatt (2014), we focus on a market with features that

might leave it open to manipulation: multiple connected markets with dierent price-order

elasticities, cash settlement, and a nite window to manipulate. The VIX setting is one

1 Aggarwal and Wu (2006) examine the history of the U.S. SEC manipulation cases from 1990 to 2001 and
nd that most occur in small and illiquid stocks. Until recently, the extent of alleged manipulation in
the press and court cases seems paltry compared to the total trading activity in bonds, equities, foreign
exchange, futures, options, and other derivatives. Manipulation in emerging markets may be more common.
For example, Khwaja and Mian (2005) document that around half of market maker prots in Pakistan arise
from manipulative `pump and dump' activities.
2 Libor manipulation was rst reported by Mollenkamp and Whitehouse (2008) and later examined by
Abrantes-Metz, Kraten, Metz, and Seow (2012) and Gandhi, Golez, Jackwerth, and Plazzi (2015). Vaughan
and Finch (2013) report a government investigation of FX manipulation. Denina and Harvey (2014) report
allegations of manipulation in gold, Benoit (2010) in silver, and Gosden (2013) and Milhench (2013) in oil.

1
with two markets with dierent liquidities and transactions costs: SPX options market with

large bid-ask spreads that make it dicult to arbitrage away price deviations, and large and

liquid VIX derivative market tied to it that translates such deviations into a sizable poten-

tial payo. Throughout the paper we refer to the SPX contracts as 'lower-level' contracts

because they are the base level option contracts that serve as inputs for calculating the value

of the VIX, through which the 'upper-level' VIX futures and options values are ultimately

3
determined at the settlement.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely tracked

index that gauges the 30-day implied volatility of the market, often referred to as a market

`fear-gauge'. Anderson, Bondarenko, and Gonzalez-Perez (2015) demonstrate that the VIX

index can exhibit deviations from true volatility due to the inclusion criteria of illiquid

options. Futures and options on the VIX have a relatively large volume. Every month, a

settlement occurs where the value of monthly VIX derivatives is set equal to the VIX value

calculated from SPX options. This settlement value is calculated from a wide range of out-

of-the-money (OTM) SPX put and call options with various exercise prices. A manipulator

would need to move the prices of these lower-level OTM SPX options at settlement to

inuence the value of expiring upper-level VIX derivatives. But, manipulators could leave

prints in the data.

Several interesting data patterns emerge. First, at the exact time of monthly VIX set-

tlement, highly statistically and economically signicant trading volume spikes occur in the

underlying SPX options. Second, the spike occurs only in the OTM SPX options that are

included in the VIX settlement calculation and not in the excluded in-the-money (ITM)

SPX options. Third, there is no spike in volume for the similar S&P 100 Index (OEX) or

SPDR S&P 500 ETF (SPY) options that are unconnected to volatility index derivatives.

Fourth, if traders sought to manipulate the VIX settlement, they would want to move the

prices by optimally spreading their trades across the SPX strikes and increasing the number

3 The connection and timing between contracts are shown graphically in Internet Appendix Figure IA.1.

2
of trades in the deep OTM put options consistent with the VIX formula. Trading volume

at settlement follows this pattern, whereas normally deep OTM options are rarely traded.

Fifth, there are certain options that have discontinuously higher weight in the VIX formula

but are otherwise very similar to other options. These options exhibit jumps in trading

volume at settlement that are not present at normal times.

We explore the alternative explanations of pent-up liquidity demand and hedging for

these patterns. The increase in trading volume of normally illiquid deep OTM put options

could be driven by pent-up demand for these options, where higher liquidity is possibly

created by the special settlement as a coordination device. However, OTM call options are

also included in the special settlement procedure, but empirical tests show that OTM calls

see lower, not higher volume at settlement as they become more OTM. This is inconsistent

with the pent-up liquidity hypothesis but consistent with traders strategically following the

VIX settlement formula which gives deeper OTM calls less weight. An alternative version of

the liquidity hypothesis is that pre-settlement liquidity may instead be positively correlated

with trading demand at settlement. However, this alternative is inconsistent with the inverse

relation between pre-settlement liquidity and settlement volume for put options. Moreover,

the volume spikes around the discontinuous weight thresholds documented previously are

inconsistent with liquidity explanations, since pre-settlement liquidity of the options are

continuous around the threshold.

To further investigate the liquidity and manipulation hypotheses, we gather data from

the European volatility index, the VSTOXX, which is similar in nature to the VIX but has

a dierent settlement procedure with only options at e0.5 and above being included in the

calculation. This design puts a very high weight on the option with e0.5, because small

changes in price can exclude or include the option from settlement calculation. Interestingly,

the trade volume per minute for options at e0.5 increases to around 130 times of that in

the rest of the day, whereas the options below this threshold experience minimal trading

activity. Additionally, the VSTOXX index is calculated every ve seconds, and the settle-

3
ment is calculated as the average of the index values between 11:30 a.m. and 12:00 p.m. A

trader trying to absorb liquidity would trade when the options with the best quotes became

available, but a manipulator would want to trade every ve seconds to optimally inuence

the index calculation. We nd that trades cluster consistently exactly at ve-second inter-

vals throughout the settlement period, whereas the thirty-minute windows before and after

exhibit no such patterns. Overall, the ndings are all consistent with the liquidity of options

at settlement being generated by those who wish to strategically trade the exact VIX or

VSTOXX formula at the exact time intervals that the indices are calculated.

We next examine two possible hedging explanations. First, we examine a trader with

hedging motives who, at some point prior to settlement, simultaneously opens a futures

contract in the upper-level VIX derivatives and hedges that position through underlying

SPX options. When the futures expire, the investor unwinds his position and liquidates the

SPX options. However, the data exhibits no such pattern in either open interest or trading

volume of SPX options prior to settlement. For the deep OTM put options, open interest

jumps more than fourfold, indicating that traders are opening new contracts and not closing

out previous positions.

The second hedging alternative is that upon expiration of VIX derivatives, investors

desire to roll their hedging positions into SPX options in a manner that exactly replicates

the VIX weighting formula. However, inconsistent with a sudden demand for such a specic

SPX position, we nd no volume jump on the VIX settlement day for other tightly related

exchange-traded products that mimic the same payo. Additionally, for four interspersed

months in our sample where there are no expiring VIX derivatives on normal settlement days,

we nd no evidence of greater underlying SPX trading either at or prior to the settlement

time, which is inconsistent with VIX investors transferring their VIX demand to SPX options.

Finally, for the VSTOXX, settlement prices are set with average prices from 11:30 a.m. to

4
12:00 p.m. CET, but futures positions expire at 12:00 p.m. Manipulators should push

4 The settlement value of VSTOXX options is also calculated using the average VSTOXX values between
11:30 a.m. and 12:00 p.m. CET, but the options can be exercised on the settlement day until 21:00 CET.

4
prices beginning at 11:30 a.m., whereas for hedgers, 12:00 p.m. is the relevant time to roll

the positions over. We see the trade volume on options used in VSTOXX calculation spikes

promptly at 11:30 a.m. on settlement days and persists only up until 12:00 p.m., with trades

clustering at ve-second intervals as discussed before. The trading activity also leads to

large movements in the value of VSTOXX index during the 30-minute settlement window

that cannot be explained by movements in the underlying index. Overall, these aggregate

patterns seem inconsistent with rollover hedging, though we expect that there are some

hedging trades also present in the data.

We examine price deviations of individual SPX options and the aggregate VIX at settle-

ment using multiple benchmarks. When comparing the VIX value at settlement to a VIX

value computed from the mid-quotes of the SPX options right after the settlement, where

both are calculated from the same range of options included in both the settlement and

the open, the two diverge by an average of 31 basis points, or 1.5% of the VIX settlement

5
value. The distortionary costs of settlement deviations to exchange-traded VIX derivatives

are approximately $1.81 billion. We examine price deviations at settlement of seven other

CBOE volatility indices with similar processes and commonly nd deviations of more than

ve percent for these small indices, highlighting the robustness and generalizability of the

ndings. In terms of the mechanics of the VIX price movement process, prices appear to be

6
moved by aggressive incremental orders in the pre-open period prior to settlement.

Overall, we nd considerable interesting activity in index options around VIX settlement.

The most natural explanation for these patterns appears to be attempted manipulation.

However, we cannot rule out other possibilities. Although we nd that the dollar distortions

in the VIX derivatives are sizeable, Spatt (2014) argues that the real economic costs of

manipulation are typically considerably larger than their direct costs; distorting market

5 The VIX deviations are considerably larger if benchmarked using adjusted option quotes from the night
before, in a systematic way that suggests the use of open prices are likely understating the deviation.
6 These results are consistent with ndings in Cao, Ghysels, and Hatheway (2000) and Biais, Hillion, and
Spatt (1999) that orders are able to move prices prior to market openings even in settings where there is
no commitment to trade.

5
prices undermines trust, hinders trade, and reduces liquidity in nancial markets. We hope

to see academic research scrutinize other markets for potential gaming and to see more eort

7
on robust market design and monitoring.

1. Related Literature, VIX Overview, and VIX Derivatives Characteristics

This section briey outlines the related literature and security features that have been shown

to lead to potential manipulation. We then examine the security design of the VIX and

whether the market exhibits these features.

1.1 Related Literature and Characteristics for Potential Manipulation

8
There is a small but growing empirical literature on potential market manipulation. Also

considerable theoretical research has examined characteristics of markets that may be con-

ducive to manipulation [e.g., Jarrow (1992), Allen and Gale (1992)]. Kumar and Seppi (1992)

and Spatt (2014) describe cross-market manipulation and identify dierent price-order elas-

ticities across markets, cash settlement, and a nite period to manipulate as main facilitators.

First, when there are multiple markets with dierent price elasticities, manipulation is more

feasible than in a single market. Because of dierent market liquidities, it may be feasible for

a manipulator to move the price of an illiquid lower-level contract that a larger upper-level

contract is tied to.

Second, manipulation is dicult for an asset with physical settlement. Suppose a ma-

nipulator pushes the price of a lower-level asset up. Nonetheless, when physical delivery of

the asset takes place, the manipulator will take possession of an asset at an inated price,

7 Anderson, Bondarenko, and Gonzalez-Perez (2015) develop a more robust measure of implied volatility that
empirically outperforms the VIX.
8 Most strikingly, Christie and Schultz (1994) showed that market makers avoided odd-eights to keep spreads
high, and that this activity was collusive. Ni, Pearson, and Poteshman (2005) nd that stock prices cluster
closer to strike prices on days with option expiration and that this behavior could be consistent with both
hedging and stock price manipulation. Golez and Jackwerth (2012) nd similar patterns of prices being
pulled toward strike prices in S&P 500 futures. Manipulation has been shown in stock prices at quarter-
ends by hedge funds (Ben-David et al, 2013) and year-ends by short-sellers (Blocher, Engelberg, and Reed,
2010).

6
and that asset may quickly fall to the original value when the manipulator tries to exit the

position. With cash settlement, a manipulator can deploy more capital in the upper-level

asset than the position size that he will take in the lower-level asset.

Third, a nite time period to manipulate prices can make the costs of manipulation

smaller. Although an auction may increase liquidity and reduce the incentive to manipulate,

it is also open to gaming. Spatt (2014) states: Although it often has been viewed that

a closing or opening auction is less vulnerable to manipulation because of the thickness

of the market, the discontinuous transition to the auction does point to vulnerabilities for

possible manipulation as illustrated by the potential for manipulating virtual (indicative)

prices during the preopening when it is not costly (or is of very limited cost) to articially

alter the price as well as the run-up to the closing auction.

Below, we examine the actual setting of the VIX settlement process and then examine

whether the features of the market as identied in the literature above allow for potential

manipulation.

1.2 VIX Mechanics

Options on the S&P 500 Index are widely traded at various strike prices and maturities.

Using the premium that investors are willing to pay for call and put options at various strike

prices, observers can calculate the implied volatility of the market. Because of this interest

by market participants, the CBOE formally calculates the VIX in real-time and updates

the index every fteen seconds using SPX options with more than 23 and less than 37 days

9
to expiration. An overview of the details of the VIX calculation is provided below and

described in more detail by the CBOE VIX White Paper (2015). To accommodate trading

demand from hedgers and speculators, the CBOE launched VIX futures on March 26, 2004

9 Before October 6, 2014 the VIX index did not use weekly options and was calculated using nearby and
second nearby monthly options with at least eight days to maturity. When the nearby options were less
than eight days to maturity, the calculation involved extrapolation using the two nearest monthly option
series with more than 30 days to maturities. The change in calculation does not aect our analysis because
the VIX settlement value is always calculated from the single monthly option series that is exactly 30 days
to maturity.

7
 10
and VIX options on February 24, 2006.

The settlement of VIX options and futures typically occurs on the third or fourth Wednes-

day of each month. The exercise-settlement value of VIX futures and options is calculated

using the auction clearing prices of SPX options in an auction called the Special Opening

Quotation (SOQ). To be included in the settlement auction, orders can be submitted and

canceled by market participants and market makers prior to market open. Starting at 7:30

a.m. CST, given the orders submitted up to each point in time, best bid and ask and in-

dicative prices for each option can be seen by market participants. Between 8:15 a.m. and

8:30 a.m., strategy orders, which are SPX option orders that are related to positions in VIX

derivatives and span over a wide range of strikes with 30 days to maturity, can no longer

be submitted or canceled. Only orders unrelated to outstanding VIX positions, including

those submitted by liquidity providers, can be submitted after 8:15 a.m. At 8:30 a.m. CST,

the CBOE executes SPX options orders at market-clearing prices and removes all remaining

unexecuted orders.

The SPX options' auction clearing prices are used in the VIX formula to calculate the

11
VIX settlement value at that point in time. Importantly, the SPX options series used in

the VIX settlement calculations are ones that expire in exactly 30 days (normally on the

third Friday of the next month). The timing of the VIX settlement and the SPX option

settlement is illustrated in Internet Appendix Figure IA.2. ITM options are not included

in the settlement value. All the OTM options are included in the settlement calculation

as long as the option is not a zero-bid option. An option is considered zero-bid if there is

no remaining bid on the option after the settlement trades are cleared. Moreover, the tails

of the option chain on both the put and call sides are cut when two consecutive zero-bid

10 ETNs and ETFs (such as tickers VXX, TVIX, UVXY, XIV) also invest long or short in VIX futures and
options, but to our knowledge, are not typically holding expiring VIX futures and options at settlement if
they employ the most common strategy of shifting money from the front month to the next month futures as
the VIX approaches maturity. Bakshi, Madan, and Panayotov (2015) note that trading volatility products
has grown rapidly, and VIX options are second most active only to SPX options.
11 In practice, more than 99.9% of options are set at the trade price. Yet, prices for non-traded options that
meet the inclusion criteria are set at the midpoint of the bid-ask spread.

8
 12
options are observed; all the deeper out-of-the-money options are excluded.

1.3 Do the VIX Derivatives Have Characteristics that Make Manipulation Possible?

Below we examine specic features of the VIX in relation to Section 1.1, which discussed

facilitating factors for manipulation. 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. Anderson,

Bondarenko, and Gonzalez-Perez (2015) show that the uctuations from inclusions of these

illiquid OTM options can lead to unnecessary variation in the VIX value. In fact, the day

prior to the settlement, deep OTM options rarely trade. Even trading a small number of

contracts can potentially move these options prices. Moreover, the large bid-ask spread of

the deep OTM options allows for large price changes inside the spread that are therefore

immune to arbitrage. Nevertheless, the time of coordinated trading at the settlement auction

may attract trading that increases the liquidity of tail options and hopefully mitigates this

issue.

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.

Third, the settlement occurs within a short period of time based on the SPX options

pre-open auction. Large buy or sell orders for the OTM SPX options in the SOQ auction

can aect the VIX settlement value by changing the options' auction-clearing price through

the demand-supply equilibrium. This means there is a nite time period where the costs

of manipulation must be incurred. While not all three conditions may be simultaneously

needed for manipulation, the occurrence of all three potentially provides a ripe setting for

12 Ifa large buy order causes a would-be zero-bid option to have a positive bid, then the option will be
included in the settlement calculation. It is also possible for an aggressive sell order that consumes all bids
greater than zero to drive the best bid price to zero. The upward pressure to include an option in the tails
might be more common because writing deep OTM put options involves large margin requirements while
buying the options does not. Santa-Clara and Saretto (2009) show that this feature has a large impact on
the capacity to write OTM puts, especially when investors write the options more aggressively.

9
protable manipulation.

2. Data and Testable Predictions

2.1 Data

Data are obtained from Tick Data, Bloomberg, the CBOE, OptionMetrics, and Deutsche

Brse Group. The datasets contain lower-level SPX options as well as upper-level VIX

futures and options. Nevertheless, most of this report's attention focuses on lower-level

SPX options, as this is where a potential manipulator would need to trade. The period

of examination is from January 2008 to April 2015, though much of our results focus on

more recent periods. For the SPX options, we use Tick Data intraday quote and trade

data with millisecond granularity for a three-day window around each settlement day from

January 2008 to April 2015. Four months of intraday data from January to April 2015 are

collected from Bloomberg to crosscheck data accuracy. We use OptionMetrics to analyze

daily patterns for SPX, OEX, and SPY options. It contains daily variables such as trade

volume and open interest. Moreover, to capture the exact trades included in settlement

calculation, we use monthly settlement reports and settlement imbalance reports issued by

CBOE.

For upper-level VIX derivatives, VIX options data are from OptionMetrics, and VIX

futures data are from the CBOE Historical Market Data, from January 2008 to April 2015.

Also, data on exchange-traded variance swaps (also called variance futures) are from CBOE,

covering the time period from December 2012 to August 2015. Historical daily and intraday

data on VIX and other volatility indices such as those on Crude Oil, Gold, Emerging Markets,

Brazil, NASDAQ-100, Russell 2000, and short-term S&P 500 are from Bloomberg. The

intraday data on the volatility indices are only available recently from October 2014 to April

2015. Finally, data on disseminated VSTOXX index and EURO STOXX 50 options that are

used to calculate the VSTOXX are from Deutsche Brse Group, and data on disseminated

EURO STOXX 50 index are from Bloomberg.

10
2.2 Overview of Testable Predictions

13
The basic steps that a manipulator needs to take include: 1) opening long positions in

the VIX derivatives prior to settlement, 2) submitting aggressive buy orders in the SPX

options during the settlement auction, and thereby causing the auction-clearing prices of

SPX options, and as a result, VIX settlement price to rise, and 3) obtaining the higher price

for the upper-level futures or options when they settle. Note that while the example shows

an upward manipulation, a trader could also manipulate the VIX downward by trading in

the reverse fashion.

Trading in an attempt to manipulate the VIX settlement should leave patterns in the

data that can be examined. First, volume spikes in the SPX options will be examined at

the VIX settlement. Second, this activity will be compared to: a) non-settlement times, b)

OEX options for the S&P 100, and c) SPY options for SPDR S&P 500 ETF that do not

have tradable upper-level derivatives. Third, SPX options volume will be compared between

SPX OTM options that are included in the VIX settlement and ITM options that are not

included.

VIX is calculated based on the following formula:

v
u  2
u 2 X Ki 1 F
VIX = 100 t RT
e Q(Ki ) 1
T i Ki2 T K0

where T is time to expiration, R is the risk-free interest rate, Ki is the strike price for the

ith OTM option, Q(Ki ) is the price of that option, Ki is the average distance between the

strike price of the ith OTM option and the strike prices above and below option i, F is the

forward index level, and K0 is the rst strike price below the forward index level. Given that

only OTM options are included, options with Ki > K 0 are calls, those with Ki < K 0 are

puts, and for Ki = K0 both calls and puts are included, each receiving half the weight.

Note that the strike price Ki in the VIX formula above is squared and in the denominator.
13 These are shown graphically in Figure IA.3.

11
Hence, as put options become more OTM (i.e. have a lower strike price), VIX becomes more

14
sensitive to their price changes. It can be shown that the manipulator would spread their

volume across the options in a manner directly proportional to the sensitivity of VIX to

price changes in each option contract (as illustrated in Internet Appendix IA.A). Thus, our

fourth point of examination is that volume and relative price deviations should increase as

put options become more OTM.

Finally, the VIX formula provides for a direct relationship between the VIX and the

variable Ki , which is the average distance between the strike price of the option i and

the strike prices of the options immediately above and below option i. For example, many

options are separated by only ve points from the nearest options on each side. If an OTM

put option has a strike of 1395, and the strikes below and above that option are 1390 and

1400 respectively, then the average distance between the surrounding strikes is ve index

points ((1400 - 1390) 2 or K = 5).15 Next, suppose that below the 1390 option is a put

option with a strike of 1375. In this case, the 1390 option would be 15 points away from

the nearest strike below and 5 points from the strike above, resulting in an average strike

dierence of 10 ((1395 - 1375) 2 or K = 10). Hence, the option at 1390 will have nearly
twice as much weight in the VIX settlement calculation as the very similar option next to it

at 1400 or 1395. If a manipulator is planning to inuence the price of the VIX, they should

be willing to spend twice as much to inuence the 1390 option as compared to the option

at 1400 or 1395. The prediction is that trading should increase around the Ki thresholds,

where certain options receive a higher weight in the VIX calculation.

14 The eect of the strike price is the opposite for call options after controlling for K measure: the deeper
OTM a call option, the higher its strike price and lower its weight in VIX calculation. This is shown in
Internet Appendix Table IA.1 where we control for K and in Figure IA.4 where we show the sensitivity
and volume only for call options with K = 5. To avoid unnecessary complexities and confusion, we
report most of the results only for put options here, which also have a higher weight in VIX calculations.
The equivalent results for the calls are reported in the Internet Appendix.
15 This is shown in Internet Appendix Figure IA.5 for a put option.

12
3. Volume Patterns at Settlement

This section will test the predictions outlined in the previous section.

3.1 Volume Spikes

Panel A of Figure 1 shows average daily volume across all SPX options. Typically, volume

is low and increases as options approach expiration. However, here the volume spikes thirty

days prior to expiration. This is not due to any kind of obvious S&P 500 market-related

event, but it is the date that the VIX settles.

Panel B removes the SPX volume that trades exactly at the settlement of the VIX, thirty

days before SPX expires. The volume for the rest of the day shows that the pronounced

spike is not present aside from settlement trades, implying that the spike is driven by the

settlement volume.

To examine the possibility that some other event besides the VIX settlement causes

volume to spike, the volume of SPX options is compared to OEX and SPY options. The

S&P 100 and 500 track each other very closely. Additionally, there is an OEX volatility

index (VXO) that is calculated from OEX options and that closely tracks the VIX index.

Nevertheless, there are no tradable futures or options on the VXO and hence no incentive to

manipulate the index. Moreover, the SPY ETF tracks the S&P 500 index and has the same

fundamentals, but there is no volatility index calculated using SPY options. Panel B plots

the average volume on the OEX and SPY. The OEX and SPY volumes exhibit no major

movement thirty days prior to maturity.

The VIX formula only uses OTM options. Panel C of Figure 1 shows that the volume

spike is entirely driven by the OTM options, and there is no increase in volume for ITM

options. Table 1 conrms this result in the regression of the form:

V olumeit = 0 + 1 SettlementDayt + 2 OT Mit + 3 SettlementDayt OT Mit + t + it

13
where SettlementDayt is a dummy variable that takes the value of one if the day is a VIX

settlement day, and zero otherwise, OT Mit is a dummy variable equal to one if option i at

settlement time t is out-of-the-money and equal to zero if in-the-money, and t is the SPX

options expiration date xed eect. Throughout the paper, we use the expiration date xed

eect when possible to control for variations in volume and other characteristics of options

across dierent expiration dates and focus on the cross-section of dierent strike prices within

expiration dates.

The Table shows that a) the increase in volume on the settlement day is entirely in OTM

options (Settlement Day times OTM) and not in ITM options, which is the benchmark; b)

the increase is economically very large; and c) it is statistically signicant with a t -statistic
of 11.86. These results are consistent with SPX trading being driven by the VIX settlement.

3.2 VIX Sensitivity and Option Volumes

Panel A of Figure 2 shows how sensitive the VIX is to price changes of individual put options.

This sensitivity measure is calculated for each strike, as the basis point change in VIX as

a result of a $0.05 change in that specic option's price, while keeping prices the same for

16
all other strikes. As discussed above, someone wishing to manipulate the index should

submit increasing volume as sensitivity increases. Panel B of Figure 2 shows put options'

volume across strike price ranges at the settlement and shows that volume increases as the

put options become more OTM, which is consistent with the sensitivity patterns shown in

17
Panel A.

Table 2 examines these patterns for both puts and calls combined in an OLS regression

framework with standard errors clustered by date. Volume does increase with VIX sensitiv-

ity, and the relationship is highly statistically signicant. Additionally, this relationship is

16 To compute the marginal eect of SPX options price changes on the VIX, we use the $0.05 increment
because that is the minimum tick size of the option prices. The fact that $0.05 change is a large price
eect for low price deep OTM options does not aect the results here because we examine the costs and
benets caused by the absolute price changes in the option prices, not the relative changes.
17 Similar patterns using alternative bins of moneyness for put options are shown in Internet Appendix Figure
IA.6.

14
economically signicant, with over half of the variation in settlement volume explained by

the VIX sensitivity measure and the date xed eects.

Panel C of Figure 2 shows that the positive relationship between VIX sensitivity and

volume is only conned to the settlement. Indeed, on the day before, the day after, and the

18
rest of the settlement day, put options with higher VIX sensitivity trade signicantly less.

3.3 Discontinuity in VIX Sensitivity

The last prediction outlined in Section 2.2 is that trading volume should 1) spike on the

higher K options if someone is attempting to trade according to the VIX formula, and

2) not jump if the trading is unrelated to VIX. In the option chains used in settlement

calculations, we ag the strikes where two adjacent options have dierent K; we call it a

jump in K and denote the two adjacent strikes around the jump as high and low K .
Next, we sort the strike prices above and below each jump relative to the strike prices right at

the jump. In Figure 3, for each jump, characteristics of the put options around the jump are

normalized relative to the high K option (which has a given value of 1) and then averaged

19
across dierent jumps. Panel A of Figure 3 plots the sensitivity of the put options around

the thresholds. Higher K translates into a higher VIX sensitivity and, by construction,

there is a jump in the sensitivity of the options around the threshold. We ask whether

trading volume exhibits a similar jump as might occur from a strategic manipulator.

Panel B shows a large jump in trading volume right at the threshold for put options.

20
The dierences between the two are highly signicant. Note that other features of the

options, such as the strike price and moneyness do not exhibit a jump around the threshold

18 Similar patterns for call options are shown in Internet Appendix Figure IA.7.
19 For instance, the option labeled zero on the x-axis of the graph represents the high K put option, for
which all the characteristics are normalized to 1. The point ten units to the left represents the tenth strike
price below the high K option. For puts, the jump in K normally occurs when one moves to an option
with a lower strike. VIX sensitivity, trade volume, strike price, and moneyness for the option contracts
around the jumps are normalized relative to the high K option and then averaged across dierent jumps.
20 Table IA.2 formalizes the test for the trade volume around the jump. A t -test shows large dierence in
settlement volume for strikes around the jump in Panel A. Panel B reports the results of an instrumental
variable regression of volume on VIX sensitivity using the jump as an instrument for the sensitivity, which
veries the signicant dierence in settlement volume around the jump.

15
(as shown in Figure IA.8). In other words, these options around the threshold are nearly

21
identical except for their greater weights in the VIX calculation. It could be argued that

the volume on options with a wider gap between the strike prices above and below should

be normally larger, as they cover a wider range of demand for adjacent missing strike prices.

Both Panels A and B of Table IA.2 show that volume does not jump with K at non-

settlement times.

3.4 Evidence Overview

Overall, this section has shown the existence of a volume spike that only occurs at the time

of the VIX settlement. The patterns are only present in SPX options and not in nearly

identical OEX or SPY options, and only in OTM SPX options that are included in the

VIX settlement calculation and not in ITM options that are excluded. VIX exhibits an

increasing sensitivity to the price of put options that are deeper OTM and, consistent with

this relationship, there is a strong and statistically signicant increase in volume as put

options become more OTM, but only at the settlement. Finally, VIX is more sensitive to

contracts that are further apart from other options, and accordingly, these contracts exhibit

an economically large and statistically signicant jump in volume on settlement that mirrors

their importance in the VIX formula. In sum, the evidence is consistent with attempted

manipulative activity, but there are other potential explanations to examine.

4. Alternative Explanations

There are three main alternative explanations for the observed patterns in the data. First,

the settlement is a period of coordinated liquidity trading. Because deep OTM SPX options

are infrequently traded and have low liquidity, traders could be concentrating their trading

around the settlement auction to take advantage of the higher liquidity of the options at

that point. Second, hedgers could take out positions in the underlying SPX options prior to

21 Internet Appendix Figure IA.9. reports similar patterns for call options.

16
settlement to hedge their VIX derivative position and then close out their position when the

VIX derivatives settle. Third, hedgers could be rolling over their VIX derivative positions

to underlying SPX options when they expire. We investigate these explanations below.

4.1 Trading Illiquid Options at the Liquid Settlement Time

Deep OTM options are normally very illiquid and costly to trade because of high bid-ask

spreads. We posit that the VIX settlement auction, in conjunction with a belief that other

traders participate in the auction, provides an opportunity for those who have pent-up

demand to trade deep OTM options. Thus, the patterns of increasing volume for deep OTM

options may just be a result of the settlement being used as a coordination device. We provide

multiple tests here that help disentangle the liquidity and manipulation explanations.

First, if the settlement auction is a period of coordinated liquidity for all options, the

liquidity hypothesis predicts higher volume for deep OTM options. This includes the illiquid

22
deep OTM call options as well as deep OTM puts. However, while the manipulation

hypothesis has the same prediction for put options, it predicts less volume at settlement for

normally illiquid deep OTM calls, because as call options become more OTM (and thus less

liquid), they receive a lower weight in VIX calculation. Therefore, we can disentangle the

two hypotheses by testing the relationship between non-settlement liquidity and settlement

trade volume across the strikes of the call options: liquidity trading predicts a negative

relationship and manipulation predicts a positive relationship. We proxy for liquidity in

non-settlement times by using the average of prior 30-day volume as well as the average of

prior 30-day inverse percentage bid-ask spread. Table 3 columns 1 and 2 report that the

settlement volume of call options is positively correlated with the two liquidity measures, or

that less liquid calls actually trade less at settlement. This relationship is inconsistent with

the liquidity hypothesis that predicts more settlement trading in the less liquid options, but

consistent with the manipulation hypothesis because the deep OTM call options actually

22 Table
IA.3 reports a positive relationship between moneyness and the liquidity at pre-settlement times for
both OTM put and call options.

17
have lower weight in VIX calculations than less OTM options. Columns 3 and 4 verify that,

as predicted by both hypotheses, less liquid, deeper OTM put options have a higher volume

at settlement.

Second, to further separate the two hypotheses for the put options, we can regress their

settlement volume on the two liquidity measures above and the VIX sensitivity measure

derived in Section 3.2 to see which one has a stronger eect. Columns 5 and 6 of Table 3

show such results. When including the VIX sensitivity measure and the liquidity measures

in the same regressions, the liquidity measures lose their explanatory power. Non-settlement

trade volume becomes marginally signicant with a t -statistic of 2.16 and non-settlement

percentage spread becomes insignicant with a t -statistic of 1.79. In both specications, the

VIX sensitivity measure is highly statistically and economically signicant with t -statistics
of 3.33 and 3.19, respectively. These ndings suggest that the volume at settlement is

primarily driven based on the VIX formula. Additionally, in Figure 2, Panel B, there is

almost no trading in ITM options at settlement, even though they are also part of the SOQ;

since the dierence is that their prices are not included in the VIX settlement, this is also

more consistent with manipulation hypothesis.

An alternative version of the liquidity hypothesis is that the liquidity of options before

settlement is a leading indicator for demand during the settlement. This hypothesis would

suggest that options that trade more in pre-settlement period are also expected to trade more

at settlement. However, this alternative liquidity hypothesis would be inconsistent with the

volume of the OTM put options, which see an increase in trading at settlement as options

become more OTM, despite little pre-settlement trading. This alternative explanation would

also be inconsistent with near the money ITM options which see high trade volume at other

times, but almost none at settlement. Hence, a uniform liquidity hypothesis cannot explain

the fact that at settlement, illiquid OTM puts trade more while illiquid OTM calls trade

less.

Third, Internet Appendix Figures IA.10 and IA.11 show the volume across strike prices

18
for all non-settlement days in the sample, divided into aggregate volume quantiles. Even in

the top 5% days in terms of aggregate volume, which have a very similar daily volume as

the settlement days, the options trade in the opposite pattern as the settlement trades. This

suggests that if there is pent-up demand for illiquid SPX options, it is not leading to trading

on other days of high trading activity.

Fourth, it is worth returning to the discontinuities examined previously in Section 3.3.

The pent-up liquidity hypothesis predicts that volume in illiquid options should increase

at settlement, but there is no reason why volume should experience large jumps around

certain thresholds, unless they also have discontinuous liquidity at other times. But, both

Panels A and B of Table IA.2 show that at normal times volume is continuous around the

thresholds. Thus, the discontinuities in trading at the settlement cannot simply be explained

by coordinated liquidity trading, but are consistent with trading based on the VIX formula.

Fifth, we turn to the European VIX, VSTOXX, which has a very similar structure to the

U.S. VIX, but has important features in the settlement calculation that dier from VIX. The

European VIX excludes options with prices less than e0.5 from the VSTOXX calculation.

The manipulation hypothesis predicts that traders who want to manipulate the prices would

not trade deep OTM options that are far below the e0.5 cuto; the e0.5 cuto is critical

23
for a trader who wishes to aect the settlement. The liquidity hypothesis predicts trading

in deep OTM puts close to expiration because this is a time of coordinated trading for

illiquid options; the e0.5 cuto is not a critical threshold for coordinated liquidity trading.

Figure 4, Panel A, shows the trade volume of EURO STOXX put options that are used

to calculate VSTOXX, sorted relative to the e0.5 cuto, and averaged across settlement

dates. Those options on the left side of the vertical line have an average trade price of less

than e0.5 during settlement period. First, the volume is particularly high for options near

the e0.5 cuto because those options are very critical to the settlement calculations; they

23 Ifthere are more than one strike with the price equal to e0.5, only the nearest to the money will be
included in the VSTOXX. But if no other strike trades at 0.5 Euro, pushing the e0.4 option up aects the
calculation. Moreover, if price of the e0.5 option at cuto is pushed upward to e0.6, then another strike
can be added to the tail at e0.5. This makes the e0.5 option highly critical in VSTOXX settlement.

19
are at risk of total exclusion or inclusion from calculations due to even small price changes.

Second, there is little volume on options that are worth less than e0.5 (and do not aect the
24
VSTOXX calculation). In the U.S. VIX settlements there is no such cuto. On average, if

one compared to the U.S. VIX calculation, 38 put options of less than e0.5 ($0.67 on average
over the sample period) have large volume and are included in each U.S. VIX settlement,

with an average trade volume of 2111 contracts. Those options account for 52% of the

aggregate settlement volume for put options over the entire sample period. Empirically, we

see activity in deep OTM options in the U.S. where they have inuence on VIX, but almost

no activity in Europe where they have no inuence on VSTOXX.

Sixth, the VSTOXX settlement is calculated using the average of the normal VSTOXX

index over a thirty-minute settlement window. The VSTOXX index is calculated every

ve seconds. Since there is no special auction procedure for VSTOXX settlement, there is

no particular reason why liquidity traders should trade at a set frequency. However, for

a manipulator who wants to aect the settlement value, it is optimal to trade every ve

seconds. To examine this, in Figure 4, Panel B, we divide every ve-second interval during

the settlement window into fty buckets of 100 milliseconds (one-tenth of a second) each.

Then, in the rst ve minutes of the settlement we identify the bucket with the highest

number of trades and use the time of that bucket to set the clock to zero. We plot the

number of trades in 100-millisecond buckets in each minute in the next 25 minutes of the

settlement period. The graph shows that the trades are clustered nearly exactly at ve-

second intervals, meaning that the 100-millisecond bucket in each ve-second interval with

the highest trading is exactly the same bucket across dierent ve-second intervals. To

examine if this type of systematic trading every ve seconds is normal, we perform the same

exercise in the 30-minute window before and after the settlement. We nd no such clustering

patterns outside the settlement (Figure IA.13).

Overall, the dierences in the volume patterns between puts and calls, ITM and OTM

24 Figure IA.12 shows the volume over time for options around the cuto on settlement days.

20
options, discontinuities within the VIX and VSTOXX calculations, and the dierences in

volume patterns and timing of trades between the VIX and VSTOXX are most consistent

with aggregate trading volume patterns capturing gaming of the respective settlement formu-

las. Although many features of the aggregate patterns do not support a consistent liquidity

trading hypothesis, the settlement likely contains a mix of trading motives, including those

seeking liquidity.

4.2 Unwinding Previous Hedging Positions

When investors open a position on VIX derivatives, they may hedge those positions by

trading in SPX options. Right at the settlement time, because VIX derivatives expire,

investors may unwind SPX hedging positions, leading to the abnormal trading patterns.

The trader could accept that a static hedge will not replicate the VIX perfectly because

of market moves, yet sit on the two positions until VIX future maturity. Then, at VIX

settlement, the VIX positions expire and the trader simultaneously unwinds his SPX trades.

This rough hedge could explain the volume spike.

To examine this possibility, we look at two tests. First, if someone takes positions in

options prior to expiration and then unloads his or her SPX positions when the VIX settles,

there should be sizeable open interest and volume in the options before the settlement. Panel

A of Internet Appendix Figure IA.14 shows that the open interest of deep OTM put options

prior to settlement is minimal, indicating that there is seemingly little hedging activity in

listed SPX options prior to the settlement. Moreover, the large increase in open interest at

25
settlement indicates that most of the activity is due to opening new positions.

Second, we examine the options that are right at the threshold of being ITM or OTM. It

is nearly impossible for a trader to know exactly which options will be included in settlement

when he opens the hedging positions in SPX options a couple of weeks (or even a couple of

25 Panel B of Figure IA.14 shows that the total volume of deep OTM puts in the prior 30 days is well below
the volume on the settlement day, again indicating that traders are not simply liquidating hedging positions
at the settlement even for a static hedging portfolio of SPX options. Figure IA.15 shows similar results for
call options.

21
 26
days) prior to settlement. When settlement time comes, the trader will have some options

that were OTM in the past but now are ITM and therefore not included in the VIX. The

trader should still unwind these positions at settlement because they no longer have the

need to hedge. Therefore, we should see volume spikes for both barely OTM and barely

ITM options. We nd that for the options that are clearly ITM, there is almost no trading

27
at the VIX settlement. This is again inconsistent with the hypothesis that the trading is

driven by a hedger who unwinds the hedge position opened before the settlement.

4.3 Replacing VIX Derivatives with SPX Options

The second hedging hypothesis is that at exactly the same time that the upper-level VIX

derivatives expire, traders replace them with SPX options through an order designed using

the VIX weighting formula. This trade would replicate a variance swap contract and hence

we will refer to it as a synthetic variance swap. The question is whether the motivation of the

trade is to hedge or to inuence VIX settlement, and we provide three tests to disentangle

the two hypotheses.

First, we look to the four months in our sample without VIX derivative contracts in the

market. This goes back to 2005 when VIX futures were relatively new. If option traders had

a need to hedge short-run volatility using SPX options, then we would expect to observe

large amounts of SPX options trading that replicates the variance swap in the months with

no VIX futures. We rst compare the volume in the settlement period between months

with and without VIX futures. Panel A of Table IA.4 shows that even though months with

and without VIX futures do not have a signicantly dierent volume for ITM put options

at normal settlement times, the trade volume of OTM put options is signicantly higher

26 The average daily volatility of the S&P 500 over the last ve years is 0.99%. With an SPX level around
2,000, this corresponds to a 19.8 points movement per day in index value of the SPX. With most at-the-
money option chains ve points apart, this means that three option contracts cannot be determined to be
in either OTM or ITM even a day prior to expiration. At one week intervals, the average volatility would
be roughly 2.61, which translates to 52.2 points or 10 contracts that may or may not be included in the
settlement.
27 These results are displayed in Figure IA.16.

22
 28
for months with expiring futures. Additionally, Table IA.4, Panel B, shows that the open

interest of OTM put options before settlement is very similar between the months with and

without VIX futures. This indicates that in months without near-term VIX futures, there

is no strong demand for replicating short-term variance swaps, which is inconsistent with

the hedging explanation but consistent with either lack of a trade coordination device or

manipulation incentives associated with the settlement.

Second, we investigate the trade patterns on exchange-traded variance swaps around

the settlement times. Variance swaps have long been traded on OTC markets and had

started trading on the CBOE as S&P 500 Variance Futures in December 2012. Unlike

OTC variance swaps, the daily data on trade volume and open interest of the exchange-

traded variance swaps are publicly available. If traders tend to replace VIX derivatives at

expiration with variance swaps, one would expect to see concentrated trading of exchange-

traded variance swaps around the VIX settlement time, but there is no spike in trade volume

and open interest of that product on the VIX settlement day (as shown in Internet Appendix

Figure IA.18).

Third, dierences in the settlement calculation of the VSTOXX provides the opportunity

to disentangle the timing of manipulation versus hedging. The last trading time of VSTOXX

derivatives and the time contracts settle is at 12:00 p.m. CET. Unlike the U.S., there is no

special auction mechanism for the settlement. Instead, the settlement is calculated using a

30-minute average of the disseminated VSTOXX value, computed every ve seconds between

11:30 a.m. and 12 p.m. To manipulate the VSTOXX settlement, it is not eective to push

the prices right at the expiration, and one needs to push the prices continuously during the

30-minute settlement at ve-second calculation intervals as discussed before. Therefore, the

manipulation hypothesis predicts that we should observe abnormal activities in VSTOXX

market during the entire 30-minute settlement calculation. In contrast, if the purpose is

to replace the expiring upper-level derivatives with lower-level options at expiration, the

28 These results are also shown graphically in Internet Appendix Figure IA.17.

23
activities should concentrate at 12 p.m. when the positions expire. For coordinated liquidity

purposes, this might also be the time to trade as hedgers roll over their positions. If a trader

wished to exit an upper-level VSTOXX position earlier, it could be done at any point in the

data, and there is certainly nothing special about 11:30 a.m.

Figure 5 Panel A shows that the trade volume of EURO STOXX 50 options jumps right

at 11:30 a.m. and stays high until 12 p.m. This only occurs for OTM options and there

is not much activity in ITM options that are not used in the settlement. Moreover, to

examine whether these trades aect the value of the VSTOXX index, Panel B of Figure

5 shows the absolute ve-second percentage changes of the VSTOXX index, averaged over

ve-minute intervals for settlements between January 2014 and August 2015. The changes

signicantly increase exactly at 11:30 a.m. To test whether these movements are caused by

market movements, we estimate a ve-minute rolling regression of VSTOXX values on EURO

STOXX 50 index, which is highly negatively correlated with VSTOXX. We then estimate

the prediction error of the next VSTOXX observation. Figure 5 Panel C shows that the

prediction error signicantly increases right at 11:30 a.m., indicating that the higher changes

in VSTOXX are disconnected from market movements. Table 4 presents these results more

formally. The absolute percentage changes and the prediction errors are signicantly larger

29
during the entire 30-minute time period of settlement calculation. We also do not see a

volume spike at 12 p.m., which would be consistent with traders rolling over their positions

when they expire.

In sum, there is nothing special about 11:30 a.m. for hedgers since their positions expire

at 12 p.m. The fact that these abnormal patterns do not spike at 12 p.m. is inconsistent with

both hedging hypotheses, but the elevation at 11:30 a.m. strongly supports the manipulation

hypothesis. Additionally, the clustering of trades every ve seconds and the jump in trading

29 Additionally,in the Internet Appendix Figure IA.19, as an example of an actual settlement with suspicious
swings, we report the most recent settlement in our data, August 2015. Here the VIX went up at 11:30
a.m. by 63 basis points and stayed up until 12 p.m., but fell back down to within 4 basis points of the
starting point by 12:05 a.m. Over this time the STOXX index experienced only a small upward move.
Other deviation patterns are typically not as large as this settlement, but price volatility consistently
sharply elevates at 11:30 a.m.

24
around the e0.5 threshold discussed before are also inconsistent with both hedging expla-

nations. Overall, our tests indicate that liquidity and hedging hypotheses are not complete

explanations for the patterns that we see in the data, though we expect that the aggregate

activities contain a mix of coordinated liquidity, hedging, and manipulative trading.

5. Prices, Costs, and Mechanics of Manipulation

This section examines whether traders are successful in moving prices and if the distortionary

costs in the VIX derivative market are sizable, whether the costs of pushing prices are justied

by its benets, whether the price deviations could be arbitraged away, and nally what the

mechanics of the pre-open activity are that cause the price deviations.

5.1 Are Traders Successful in Moving the Prices?

We now ask if prices move at the settlement, and by how much. We examine the price

movements for individual SPX options, how that translates into deviations in the aggregate

VIX, and how the eect is spread across dierent options.

5.1.1 Price Movements in Individual SPX Options

We examine potential price deviations in individual SPX options by comparing the prices of

SPX options at settlement with their rst observable price after the market opens (typically

between 8:30 a.m. and 8:31 a.m.), as well as prices at the close of the day before. We

adjust the open prices of SPX options for movement of the underlying index and the time

decay between the settlement to the open, and previous close prices for movement of the

underlying index, time decay, and overnight changes in volatility, proxied by changes in the

30
second-term VIX futures. To examine the patterns separately for settlements with positive

and negative price pressure on the VIX, we rst measure deviations of the aggregate VIX

settlement relative to the VIX values right after the market opens. To examine upward and

30 The procedures are detailed in Internet Appendix IA.B.

25
downward price pressure separately, we divide the sample into settlements with large positive

deviations (more than +20bp) and large negative deviations (less than -20bp) relative to the

open benchmark.

To examine the settlement prices relative to the bid-ask spread after the settlement, we

31
sort options into bins based on their bid-ask spread right after the market opens and then

pool them across settlement days. Panel A of Figure 6 reports the settlement prices of the

put options relative to the spread at the open, where the size of the bubbles is proportional

to the number of observations at each price. For days with large positive deviations, most

prices are above the mid-point, and generally cluster slightly below or close to the ask price.

Some observations are even above the ask price. For example, for the SPX options with

bid-ask spread of 50 cents after the open, most settlement prices are close to the ask, but

some go up to 90 cents above the mid-quote. A similar pattern holds across dierent bid-ask

spreads. The prices cluster close to the bid in days with large negative deviations.

Given that the settlements are sorted into positive and negative deviations based on

the deviation of the VIX settlement relative to the VIX right after the open, we examine

an alternative benchmark for individual SPX options that is not aected by the way VIX

deviations are dened. Thus, we compare the individual SPX options settlement prices

relative to the option quotes at the close of the previous day (while sorting the settlement

days relative to the open). As shown in Panel B, this yields very similar patterns: In days

with positive (negative) deviation of the VIX settlement relative to the open, SPX option

prices cluster near the ask (bid) of the previous close.

Table IA.5 reports the paired t -test of the individual SPX put option prices at settlement
compared to the quotes at the market open and the previous close. Panel A shows that in

days with positive deviations, settlement prices are signicantly 18 cents above the mid

quotes and 38 cents above the bid, while they are pushed all the way towards the ask prices.

31 For options with missing quotes or quotes that are strictly inferior to other strikes in the same option
series, we use quotes of options that strictly dominate that option, i.e. the best ask of the more ITM
options or the best bid of the more OTM options.

26
In days with negative deviation, prices are 18 cents below the mid-quotes and 34 cents below

the ask, but not statistically dierent from the bid. Panel B nds similar results when option

prices are compared to the previous close.

We formally test whether price changes at settlement are a transitory eect. Table

IA.6 estimates a regression of the price changes from settlement to market open on the

changes from the previous close to the settlement. The prices here are adjusted for the index

movement, time decay, and volatility changes as explained before. The reported R-squared

shows that 74% (57%) of the price changes of individual options from settlement to open for

put (call) options can be explained by the changes from the previous close to the settlement.

This result conrms that the price deviation is indeed a transitory eect related to the

orders submitted at the settlement. The overall results in this section suggest that SPX

option prices at settlement systematically deviate from the mid-quote of the previous close

across the strike prices and then revert back towards the mid-quote after the settlement.

5.1.2 Deviations in the Aggregate VIX

To gauge how movements in SPX options prices translate into aggregate deviations of the

VIX, we compare the VIX index calculated from the SPX options prices at settlement to

the VIX index calculated from the mid-quote of the SPX options right after the market

32
open. To control for deviations that could be caused by including dierent range of strikes

at settlement and at the benchmark, we conservatively use the exact same range of non-

zero bid options included in both the settlement and the open. We call this the open

benchmark. Figure 7, Panel A, shows the deviations in the VIX from January 2008 to April

33
2015. The deviations can be either positive or negative, and the average absolute value of

the deviations is 31 basis points per settlement day. The deviations appear largest in late

2010 and in 2011, and are generally smallest in 2014.

32 There
is on average a 25 second dierence between the settlement and the prices used here.
33 The
average raw deviation is -0.5 basis points and the median is 2.5 basis points. Of the absolute deviations
of more than 20 basis points, 57% of the deviations are positive and 43% are negative.

27
 We also benchmark for an objective value of the VIX at settlement using three alternative

measures, all calculated from the same range of individual SPX options included in the

settlement and the open: 1) a VIX index computed using the raw mid-quotes of the previous

close and then adjusted by adding the overnight changes in the second-term VIX futures, 2)

a synthetic VIX using the value of OTM options implied from the mid-quotes of ITM options

through put-call parity, and 3) a VIX index computed from the adjusted mid-quotes of the

SPX options at the previous close, adjusted for changes in market conditions as discussed in

34
section 5.1.1. All of the benchmarks use the same range of non-zero bid options included

in both the settlement and the open right after the settlement.

Table IA.7, Panel A, shows that the deviations from the open benchmark and the other

measures are highly correlated with estimates ranging from 0.74 to 0.79, and all signicant

at the 0.001 level. During the sample period from May 2010 in which all benchmarks

are available, the average absolute deviation is 27bp relative to the open benchmark, 61bp

relative to the previous close (adjusted for changes in second-term VIX futures), 34bp relative

to the ITM benchmark, and 57bp relative to the index calculated from the adjusted quotes

of individual SPX options at the previous close.

The open benchmark may underestimate the deviations if it contains a spillover of price

and quote changes from the settlement. This seems to be the case. We nd that on days

with positive deviations of settlement relative to open, the deviations of settlement relative

to previous close are even signicantly more positive, and on days with negative deviations

of settlement relative to open, deviations from previous close are even signicantly more

35
negative. Nevertheless, we still use the open benchmark as the main reference to dene

the deviations and market distortions in the paper because it is the most conservative and

conceptually simplest benchmark for the VIX settlement values given that it is computed

34 Construction of the benchmarks 2) and 3) requires information from the settlement imbalance reports,
which limits the sample period for those benchmarks to after May 2010. The details of calculations are
explained in the Internet Appendix IA.C.
35 Panel B of Table IA.7 reports this using a paired t -test of the dierence between deviations from open and
previous close for the full sample where both the open benchmark and the previous close benchmark are
available.

28
less than 30 seconds after the settlement.

5.1.3 The Source of Deviations

We now examine the sources of the aggregate VIX deviations across dierent SPX options

strike prices. For each settlement, we divide the sample of put options into three subgroups

with equal number of strikes based on their moneyness: 1) Close-in OTM Puts, 2) Deeper

OTM Puts, and 3) Very Deep OTM Puts. We examine call options as a separate group. The

put option subgroups contain 31-32 strikes on average at each settlement and the call group

contains 36 strikes. The VIX deviation caused by each group is calculated by aggregating the

deviation caused by each individual option in that subgroup settled at the actual settlement

price, while holding the price of the other options the same as the benchmark. We do this

both using prices at open and the adjusted prices at the previous close. In days with large

positive deviations, 29% of the deviations are caused by close-in OTM puts, 22% from deeper

OTM puts, 22% from very deep OTM puts, and 28% from the calls. The numbers are 44%,

36
24%, 10%, and 23% for negative days (as reported in Table IA.8, Panel A). Although the

volume is much higher in deeper OTM put options, the prices are much smaller, which is

why close-in-OTM options still carry relatively more weight in the total deviation. Overall,

if one calculates the basis points of VIX deviation per money overpaid in the SPX option

market relative to the benchmarks, each group of options gives similar deviation per dollar

overpaid, as shown in rows four and ve of both panels. This is because in general the trade

volume is spread across strike prices increasing for the smaller-priced put options, consistent

with the optimal trading strategy shown in the Internet Appendix IA.A.

36 It
should be noted that to control for the range of options included in the settlement and the benchmark, we
use the exact same non-zero bid options included in both the settlement and open benchmark calculation
and ignore the tail-extension or tail-cutting eect that causes deviation in the very deep OTM options.
The numbers relative to the previous close are comparable, as reported in Panel B.

29
5.2 Are the Market Distortions Sizable?

The market distortion caused by the settlement deviations can be calculated by multiplying

the dierence between the settlement and the open benchmark by the open interest of the

37
VIX derivatives at settlement. This measure reects the deviation of the settlement prices

of the SPX options from the mid-quotes right after the market opens. This calculation is

made on both VIX futures and ITM VIX options for each settlement date. Panel B of Figure

7 plots the monthly dollar distortions of futures and options. The distortionary costs vary

widely across settlements, and more of the costs are born on the VIX options.

The distortions are the largest in 2011, 2012, and 2013 respectively, and they are not

caused by 2008 market events when the VIX reached historic high. As reported in Internet

Appendix Table IA.9, across the sample period of January 2008 to April 2015, the distor-

38
tionary costs to the upper-level futures and options were $1.81 billion. Our deviations are

also overly-conservative because deviations are measured only for individual SPX options

that are included in the VIX both at the settlement and at the open. If we include the

tail-eect (more in Section 5.5) by allowing the settlement and benchmark have their actual

range of options included in the VIX, the distortion is $1.95 billion. These ndings highlight

a sizeable wealth transfer taking place from the investors on one side of trades in the VIX

derivatives to the other.

Interestingly, the VIX is not the only volatility index with a similar settlement design.

Crude oil, iShares MSCI emerging markets ETF, Russell 2000, iShares MSCI Brazil ETF,

NASDAQ 100, short-term S&P 500, and gold all had volatility indices with tradable upper-

39
level futures or options until most of them were recently suspended. Panel C of Figure

37 The open benchmark is calculated using the mid-quotes of the exact range of SPX options included in both
settlement and right after the open. Only if the required SPX series do not open in the data right after
the market opens, we use the ocially disseminated VIX at open as the benchmark, which only happens
in ve settlement days.
38 The average distortionary cost is $21 million per settlement. Moreover, our calculations do not include
OTC positions and hence may be understated. Additionally, recall that the deviations here use the open-
benchmark, which as noted earlier, was the most conservative of benchmark methods.
39 The contracts for crude oil, gold, and Brazil ETFs were discontinued after May 2015, the contracts for
short-term S&P 500 and NASDAQ 100 after June 2015, and the contracts for the emerging markets ETF

30
7 plots the deviations at settlement and shows that magnitudes are commonly over 5%

deviations. Because the volume in the upper-level contracts is thin, the total distortion in

all contracts only amounts to $11.34 million dollars (as calculated in Table IA.10). The

settlement deviations in other indices indicate the generalizability of these ndings and the

need to consider a better settlement design.

5.3 Do Deviations Provide Arbitrage Opportunities?

Do the settlement deviations lead to potential arbitrage prots to those trading against the

deviation? For example, suppose that the true value of a deep OTM put option is $0.15.

Now someone at settlement pushes the price up to $0.25. This creates an arbitrage prot if

someone can sell the option at $0.25 and buy back at a price close to $0.15.

However, OTM SPX options usually have a high bid-ask spread outside of the settlement

and even more so for the illiquid deep OTM puts, which VIX is more sensitive to. In the

example above, if the bid and ask prices of the option are $0.05 and $0.25, there would be

no arbitrage opportunity because the arbitrageur must buy back the option at $0.25.

The CBOE reports VIX indices that are calculated from SPX options' bid prices (VIXB)

and ask prices (VIXA). Table 5 Panel A reports the summary statistics for the spread

between VIXB and VIXA at the open on settlement days over the period from January

2008 to July 2015. The average spread is an economically large 1.55 VIX units, which

translates into 6.8% of the midpoint. As long as the deviations are within the spread, it

is not the case that someone can immediately arbitrage away the deviations. Indeed, the

fact that the spread of the SPX options is large outside of the settlement means that the

VIX deviations can be large; the large spread leaves open the possibility for large deviations

that are immune to price correction. Nevertheless, given the time dierence between the

settlement and the benchmarks, we nd that 14% of the SPX options settlement prices fall

outside of the adjusted spread at open benchmark and 27% outside the adjusted spread at

after July 2015.

31
previous close, as previously shown in Figure 6.

5.4 Is the Cost of Pushing Prices in the SPX Justied by Its Benets?

If there was a single market where a manipulator had to both push the prices and collect the

payos in that market, the manipulation would not be protable, especially with the high

spread present in the SPX options market. However, here a manipulator can push the prices

of illiquid SPX options, but reap the payos in the liquid VIX derivatives market. Table 5

Panel B reports that the percentage bid-ask spread for VIX futures over the sample period

is around 0.3%, which is far less than the 6.8% spread between VIXB and VIXA calculated

from the spreads on the underlying SPX options.

For the manipulation to be protable, the prot made on the VIX derivatives should be

larger than the costs of trading and pushing prices of the SPX options. We compare the

total size of the exchange-traded VIX derivatives market at settlement relative to settlement

trades in SPX options in terms of their Vega exposure, which shows how much the value

of each market would shift as a result of change in volatility, as measured by VIX. For

example, suppose that a trader has a long position in VIX futures and wants to push the

settlement value up by buying SPX options at an inated price in the pattern that mimics

VIX weights. If the Vega of his portfolio in VIX future markets is equal the total Vega traded

in SPX options at settlement, he receives a $1 payo in VIX future market from inating

VIX settlement, but this costs him $1 on purchasing overpriced SPX options. However, if

the size of his VIX futures Vega is twice the size of traded SPX options, every dollar spent

to move the settlement would leave him with $1, or a 100% prot.

We examine the relative sizes of the markets over the sample period in Table 5 Panel C.

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 and are aected by settlement value. Together, the upper-level market is 13 times

the SPX trades at settlement in terms of Vega exposure, which indicates that manipulation

32
in the lower-level would be feasible for a trader that holds a sizable fraction of the upper-level

market.

Another consideration here is the transaction costs paid by traders to unwind the SPX

options they take at settlement. Traders can oset their exposure using other exchange-

traded or OTC products such as OTC variance swaps after the settlement, they might

be partially osetting exposure to certain option Greeks opened at some point before the

settlement, or they might directly unwind the exact SPX options after the settlement. Our

data only allows us to track the last possibility. Figure IA.20 Panel A shows that the

open interest of deep OTM put options increases right at settlement and does not decrease

afterwards, and Panel B shows that trade volume is minimal for deep OTM puts after the

settlement. Thus, traders do not seem to unwind the exact positions in the SPX option

market. More detailed investor-level data is required to examine the possibility of traders

using other derivatives or more sophisticated strategies in the SPX market to oset their

settlement positions.

5.5 What is the Mechanism through Which Prices are Pushed?

The question remains of how exactly the SPX option prices move. Biais, Hillion, and Spatt

(1999) and Cao, Ghysels, and Hatheway (2000) show that pre-open orders can convey sub-

stantial information and move prices even in the absence of any rm commitment to trade.

Spatt (2014) also emphasizes that manipulators can move these virtual prices in the absence

of trading.

To see how these orders aect prices before the settlement, we look at the order imbalance

40
reports on settlement days. The imbalance reports are issued by the CBOE and include

information such as bid and ask price, size, imbalance quantity, and last sale price, which

is used to calculate the indicative price (of what the market-clearing price would be if the

40 The
imbalance reports with a full range of strike prices start from May 2010. Here we consider positive and
negative absolute deviations of at least 20bp, which leaves us a sample of 25 days with positive deviations
and nine days with negative deviations.

33
auction clears at that time).

Figure 8 graphs the movements for the OTM put options' imbalance report indicative

prices over time. Panel A shows that, in days with large positive VIX deviations, the average

indicative SPX price starts low in the morning and increases from 7:45 a.m. to 8:15 a.m. This

is in line with aggressive buy orders moving prices upwards. However, since no VIX related

strategy order can be submitted from 8:15 a.m. to 8:30 a.m., prices typically go down after

other players including market makers dominate the market, indicating that other traders

put in orders to sell the overpriced options and adjust the prices downward. However, the

prices are not fully reversed, and we observe more downward adjustment from settlement

to open. Note that this last adjustment from settlement to open is what we use to dene

positive and negative VIX deviations, so the price movements before 8:15 a.m. and between

8:15 a.m. and 8:30 a.m. are not artifacts of how we dene positive and negative deviation.

In fact, they show how the aggressive orders before 8:15 a.m. still leave a signicant eect

on the settlement prices at 8:30 a.m., even after prices are partially corrected. Rather

than just focusing on the average, Figure 8 Panel B shows the 25%, median, and 75% of

the distribution. Note that the pattern of positive movements prior to 8:15 a.m. and a

41
downward price drift from 8:15 a.m. to 8:30 a.m. generally holds.

Table 6 shows the ndings more formally. On days with a positive deviation at settlement,

we have a signicant positive deviation from before 8 a.m. to 8:15 a.m. and then a signicant

reversal from 8:15 a.m. to 8:30 a.m. As expected, we have a negative adjustment from

settlement to market open. The results for days with a negative deviation are marginally

signicant or not signicant, although they have the expected sign.

The aggressive orders can most easily be seen in the bid-ask spread. In a balanced

market of buyers and sellers, the price to buy (bid) should never be above the sell (ask).

Yet, occasionally `crossed' markets occur when prices for the best bid exceed the best ask.

Cao, Ghysels, and Hatheway (2000) show that crossed markets are more likely in the pre-

41 Althoughthere are only nine settlement days in the sample with large negative deviations, general patterns
are in the opposite direction as shown in Figure IA.21.

34
open and are indicative of strong information signaling by certain traders.

Ten minutes after the open, the percentage bid-ask spread is positive, as one expects.

Yet at pre-open of settlement days, the spread is largely negative, indicating that traders

are submitting aggressive buy or sell orders (as shown in Figure IA.22). More interestingly,

consistent with the idea that manipulators have no incentive to aect ITM option prices, the

spread at settlement is only negative for OTM options and turns positive for ITM options.

To the extent that dierent traders have dierent positions and some traders are pushing

the prices up while others are pushing the prices downward, the manipulation eectiveness is

mitigated. Such a ght over the settlement price is also consistent with the elevated volume.

It is interesting to examine whether the magnitude of the deviations across time is related

to the time-series of trade volume at settlement. We regress the absolute value of deviations

on the Log volume at the settlement. Despite the small sample size of around 80 settlement

t
observations, the settlement volume is positively and signicantly ( -statistic=2.42) related

to the absolute VIX deviations (as shown in Table IA.11, Panel A). A one unit increase in

Log volume results in 13bp more deviations in VIX settlement. This provides conrming

evidence that the trading activity is related to the deviations.

In our previous analysis, we measured the deviations caused by non-zero bid options

that are included in both settlement and the open. This conservative method is not aected

by issues surrounding benchmarking the settlement with illiquid options, but also ignores

pushing or cutting the tails. We now examine the relationship between the range of OTM

put options included in the settlement calculation and the settlement deviations, where we

calculate the deviations using the actual range of options included in settlement relative to

42
the actual range of options trading at the open. Compared to the range of likely options

included in the settlement based on the prices the night before, the tail is longer on 53

settlements and shorter on 25 settlements. Panel B of Table IA.11 shows that there is a
42 Thisallows for dierent ranges of options at the settlement and open. The deviation calculated in this
manner is ve basis points higher than the "open benchmark" calculated with the same range of options
both at settlement and at the open that is used throughout the paper.

35
positive correlation between deviations from open and the length of the tail of put options

added to the VIX relative to the previous night.

Overall, the analysis shows that there are aggressive orders to buy or sell prior to the

market settlement that do not occur at other times and that they are related to price

deviations.

6. Conclusion

We show that not only is it feasible to inuence the VIX settlement, but also present price

and volume patterns at settlement consistent with what one would expect from such strategic

trading. In particular, a volume spike occurs: a) only at the time of the VIX settlement,

b) only in the OTM options that are used to calculate the VIX, c) not in similar S&P 100

Index (OEX) or S&P 500 ETF (SPY) options, which do not have a tradable volatility index,

d) proportional to the sensitivity of VIX to each strike price, and e) with a jump for options

that have a discontinuously higher weight in the VIX calculation, which does not occur

at non-settlement times. We thoroughly investigate alternative explanations of coordinated

liquidity and two forms of hedging but nd that these explanations do not t the data as well

as the manipulation hypothesis. These ndings have important implications for settlement

design, regulators, enforcement, and investors.

The deviations in the VIX account for an average of 31 basis points of movement in

settlement values, which amount to over $1.81 billion dollars in settlement price distortions

for the upper-level VIX futures and options from 2008 to April 2015. The large size ($108

billion dollars over our sample period) of VIX futures and options that are exposed to the

settlement relative to size of SPX options at settlement, makes manipulation cost-eective

for a large trader. Although in other markets these price deviations might create arbitrage

possibilities for (and price correction by) those trading against them, we show how the high

transaction costs in less liquid SPX options during the non-settlement window make such

deviations feasible.

36
 In sum, our ndings show that the VIX settlement appears susceptible to manipulation,

and that the aggregate evidence aligns itself with what one would expect to see in the case of

market manipulation of certain settlements. However, we cannot fully rule out all potential

explanations without more granular data.

In thinking through solutions to avoid potential manipulation, a common focal point is

often optimal security design. Market design is clearly important, but nancial complexity

makes it dicult for regulation to keep pace with changing market design, and it is naive

to think that policy makers can foresee all possible gaming mechanisms. For example, the

VSTOXX settlement procedure seems to be designed with an eye to mitigate the impact

of temporary price pressure, but nevertheless also exhibits patterns strongly indicative of

gaming the settlement. A concern is that complexity in the derivative market can be used

to obfuscate nancial deception [Partnoy (2009)]. Policies that encourage transparency in

reporting trading activities and even anonymized trader identities can counteract increasing

complexity. We hope to see more research analyzing the extent of potential gaming of market

prices in other contexts.

37
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39
 Panel A: S&P 500 Options Daily Trade Volume

Panel B: Options Daily Trade Volume (Normalized by Mean)

Figure 1. Trade Volume of S&P 500, S&P 100, and SPY Options. This gure shows
the average trade volume of monthly S&P 500, S&P 100, and SPY options by days to maturity.
The sample consists of the option chains used in VIX settlement calculations from January 2008 to
August 2014. Panel A shows the daily trade volume of S&P 500 options averaged across dierent
strike prices and settlement dates. The center vertical line shows 30 days to maturity, which is the
settlement day for VIX derivatives. Panel B shows the average daily trade volume calculated in
the same way as Panel A for S&P 500 options excluding the trades occurring at the preopening
settlement (green circles), S&P 100 options (brown squares), and SPY options (orange triangles).
The volume in Panel B is normalized by the average trade volume for each option during the period.
Panel C shows the SPX options' trade volume separately for OTM (blue circles) and ITM (gray
squares) options.

40
Panel C: OTM and ITM Options Daily Trade Volume

41
 Panel A: Put Options VIX Sensitivity

Panel B: Put Options Trade Volume at Settlement

Figure 2. VIX Sensitivity and Trade Volume of Put Options. This gure shows the
relationship between trade volume of monthly S&P 500 put options and the sensitivity of VIX
settlement value to price movements in those options. The sample consists of the put options used
in VIX settlement calculations from January 2008 to April 2015. VIX sensitivity for each option is
calculated as the change in VIX settlement value as a result of ve-cent price movements in that
option, holding all other prices constant. Each month's put options used in settlement calculation
are divided into 50 bins based on their moneyness, and the VIX sensitivity and trade volume are
averaged for each bin, and then over time. Panel A shows the average VIX sensitivity for each bin
and Panel B shows the average volume at VIX settlement. Panel C compares the settlement volume
with average volume over the rest of the day, day before, and day after.

42
Panel C: Put Options Volume at Settlement versus Daily Volume on Other Days

43
 Panel A: VIX Sensitivity

Panel B: Settlement Volume

Figure 3. Discontinuity in VIX Sensitivity and Trade Volume of Put Options. This
gure shows the discontinuity in VIX sensitivity and trade volume of put options due to the jump
in strike prices. The sample consists of the options used in VIX settlement calculations from January
2008 to April 2015. A jump is dened as when K (the average distance between a strike price and
strike prices above and below) increases for an option relative to the adjacent strike. The center
vertical lines represent the strike with high K at the jump. The strike prices above and below the
jumps are ranked relative to the strikes at the jump. Then VIX sensitivity and settlement volume
are normalized by the values of these variables for the High-K strike at the jump. The blue circles
show the average of these variables for each rank across dierent settlements. Panel A shows the
jump in VIX sensitivity and Panel B shows the jump in trade volume at settlement. The gray
areas represent the 95% condence interval for the tted values of the variable on the y-axis as a
quadratic function of the rank of options relative to the High-K option.

44
 Panel A: Trade Volume around the e0.5 Cuto

Panel B: Number of Trades over Time

Figure 4. Trading Pattern of EURO STOXX 50 Put Options during the VSTOXX
Settlement. Panel A shows the volume across strikes of EURO STOXX 50 put options around the
e0.5 cuto. For each strike, the average price over the settlement window, weighted by settlement
volume, is calculated and rounded to the nearest tick. Then the strikes are sorted relative to the
deepest OTM strike with the average price of e0.5. The blue circles show the average volume for
strikes sorted relative to the e0.5 option across settlements. The gray areas represent the 95%
condence interval for the tted values of the volume as a quadratic function of the ranks relative
to the cuto. Panel B shows the time clustering of trades during the settlement. Each ve-second
interval is divided into 50 buckets of 100 milliseconds each. The rst ve minutes of each settlement
is used to identify the bucket with the highest number of trades, and the clock is set to zero at the
time of that bucket. The graph reports the total number of trades for the 100-millisecond buckets
across each minute of the next 25 minutes of the settlement period over the sample period. The
sample consists of the settlement days from January 2014 to August 2015.

45
 Panel A: Trade Volume

Panel B: Absolute Percentage Changes

Figure 5. Trade Volume, Absolute Changes, and Prediction Error in VSTOXX Index
on Settlement Days. Panel A shows the trade volume of EURO STOXX 50 options during the
settlement days, aggregated every ve minutes and averaged across the settlements. Panel B shows
the absolute percentage changes of VSTOXX index on settlement days, calculated as the absolute
value of ve-second percentage changes in the index value, averaged every ve minutes. The sample
consists of the settlement days from January 2014 to August 2015. Panel C shows the out-of-sample
prediction errors from ve-minute rolling OLS regression of VSTOXX on EURO STOXX 50 index.
The sample consists of the settlement days from March 2015 to August 2015. The red vertical
lines mark the 30-minute window when the VSTOXX settlement value is calculated. The data is
reported every ve seconds for the VSTOXX index and every 15 seconds for the STOXX index.

46
Panel C: Absolute Prediction Errors

47
 Panel A: SPX Option Prices at Settlement Relative to the Quotes at Open
Positive VIX Deviation Relative to Open Negative VIX Deviation Relative to Open

Panel B: SPX Option Prices at Settlement Relative to the Quotes at Previous Close
Positive VIX Deviation Relative to Open Negative VIX Deviation Relative to Open

Figure 6. SPX Put Options Settlement Prices Relative to the Spread at Benchmark.
These gures show the prices of individual SPX put options at settlement relative to the bid, ask,
and mid-quote of the options at the market open immediately after the settlement (Panel A) and at
the close the day before (Panel B). Positive deviation days are those with 20bp or greater deviation
in VIX at settlement and negative deviation days are those with -20bp or less deviation. The sample
consists of the settlement days from May 2010 to April 2015. Options are pooled into the bins based
on their round bid-ask spread at 10-cent intervals and then across dierent settlement days. The
graph shows options with a spread of $1 or less. For options with missing quotes or quotes that
are strictly inferior to other strikes in the same option series, we use quotes of options that strictly
dominate that option, i.e. the best ask of the more ITM options or the best bid of the more OTM
options. The red bubbles show the settlement prices, and their size is proportional to the number
of individual SPX options in each group.

48
 Panel A: VIX Deviations at Settlement

Panel B: Market Distortion in VIX Derivatives

Figure 7. Deviation of Volatility Index Settlement and Market Distortion in VIX

Derivatives. Panel A shows the deviations in VIX settlements relative to the benchmark VIX
calculated using the mid-quotes of SPX options shortly after the settlement, where settlement and
open benchmark are calculated using the same range of options included in both settlement and
the open. If the required series of individual SPX options does not open within 70 seconds after the
market opens, the dierence between the VIX settlement and the disseminated daily open price of
VIX is used. The sample consists of the settlement dates from January 2008 to April 2015. Panel
B shows the market distortions in VIX options and futures caused by VIX settlement deviations,
calculated as the open interest of VIX futures and ITM VIX options on close of the day before
settlement multiplied by the settlement deviation. Panel C plots the settlement deviations for other
volatility indices, as benchmarked by open value of the index and as a percentage of the open index.
Data is available from 2012 to 2015 for crude oil, emerging markets, and Brazil ETFs; from 2011 to
2015 for gold; from 2014 to 2015 for Russell 2000 and S&P Short Term; and from 2007 to 2009 and
2012 to 2015 for NASDAQ.

49
Panel C: Deviations in Other Volatility Indices

50
 Panel A: Months with Positive Deviation (Average)

Panel B: Months with Positive Deviation (25, 50, and 75 Percentiles)

Figure 8. Price Movements of Put SPX Options before Market Open. This gure
shows the change in indicative price of put SPX options over time on settlement days with positive
deviations, as reported in CBOE Imbalance Reports. Prices of all put options used in settlement are
normalized by their settlement price and then averaged across all strike prices and over settlement
dates. Panel A shows the averages and Panel B the 25, 50, and 75 percentiles for days with positive
VIX settlement deviation of more than 20bp. (March 2013 and October 2014 are removed from the
sample because SPX option series do not have quotes in the data immediately after market open.)

51
Table 1. Trade Volume of OTM Options on Settlement Days. This table shows OLS
estimates where the dependent variable is daily trade volume of the SPX options in a regression of
the form:
V olumeit = 0 + 1 SettlementDayt + 2 OT Mit + 3 SettlementDayt OT Mit + t + it

where SettlementDayt is a dummy variable that takes the value of one if the day is a VIX settlement
day, and zero otherwise, OT Mit is a dummy variable equal to one if option i at settlement time t is
out-of-the-money and equal to zero if in-the-money, and t is the expiration date xed eect. The
last two columns exclude trades that occurred during the preopening settlement on settlement days
but include trades in the rest of the settlement day. The sample consists of the option chains used
in the settlement dates from January 2008 to April 2015. Reported t-statistics in parentheses are
clustered by the options' expiration date.

Including Settlement Trades Excluding Settlement Trades

Volume Volume Volume Volume
Settlement Day 57.02 54.07 -33.73 -34.24
(1.06) (0.99) (-0.72) (-0.71)

OTM 1011.3 1067.3 1009.7 1066.1

(15.47) (16.55) (15.45) (16.40)

Settlement Day OTM 1176.2 1177.9 118.2 116.9

(11.86) (11.63) (2.00) (1.94)

Constant 509.0 1580.9 508.6 1348.1

(10.24) (28.61) (10.24) (26.00)

ExDate FE No Yes No Yes

Observations 55,542 55,542 55,542 55,542
Adjusted R2 0.027 0.043 0.009 0.022
t statistics in parentheses

p < 0.05, p < 0.01, p < 0.001

52
Table 2. Eect of VIX Sensitivity on Trade Volume. This table shows the relationship
between trade volume of monthly SPX options and the sensitivity of VIX to price changes in these
options in a regression of the form:
V olumeit = 0 + 1 V IXSensitivityit + t + it

where V IXSensitivityit is constructed by calculating the absolute change in VIX settlement value
as a result of ve-cent price changes in strike i at time t, holding all the other prices constant, and
t is the date xed eect. The sample consists of the option chains used in the settlement dates
from January 2008 to April 2015. Reported t-statistics in parentheses are clustered by date.

At Settlement At Other Times

Settle Vol. Settle Vol. Day Before Rest of the Day Day After
VIX Sensitivity 5407.3 5577.5 -1427.9 -1147.1 -1507.2
(3.50) (3.60) (-4.08) (-2.80) (-3.40)

Constant 690.6 1014.4 2057.8 3759.4 5142.6

(3.80) (6.09) (54.74) (85.46) (108.03)

Date FE No Yes Yes Yes Yes

Observations 11,788 11,788 11,787 11,787 11,787
Adjusted R2 0.324 0.511 0.028 0.029 0.022
t statistics in parentheses

p < 0.05, p < 0.01, p < 0.001

53
Table 3. Eect of Non-Settlement Liquidity and VIX Sensitivity on Volume. This table
shows the relationship between settlement volume of monthly SPX options and their liquidity in
non-settlement times as well as their VIX sensitivity in regressions of the form:
V olumeit = 0 + 1 Liquidityit + 2 Kit + t + it

and
V olumeit = 0 + 1 Liquidityit + 2 V IXSensitivityit + t + it
where V IXSensitivityit is constructed by calculating the absolute change in VIX settlement value
as a result of ve-cent price changes in strike i at time t, holding all the other prices constant,
and Liquidityit is measured as either the average of prior 30 days' volume or the average of prior
30 days' inverse percentage bid-ask spread. Kit is the average distance between the strike i and
strikes above and below, and t is the date xed eect. The sample consists of the option chains
used in the settlement dates from January 2008 to April 2015. Reported t-statistics in parentheses
are clustered by date.

Call Options Volume Put Options Volume

(1) (2) (3) (4) (5) (6)
Liquidity (Volume) 0.0377 -0.0466 -0.0293
(6.33) (-6.70) (-2.16)
Liquidity (Inv. Pct. Spread) 821.9 -3370.2 -2208.2
(3.21) (-4.48) (-1.79)
Delta K 88.05 88.96 441.9 434.2
(7.27) (7.40) (5.51) (5.34)
VIX Sensitivity 5364.7 5275.1
(3.33) (3.19)
Constant 362.2 211.4 -1263.1 -1019.8 1448.3 1581.3
(5.08) (2.33) (-2.01) (-1.55) (6.25) (5.25)
Date FE Yes Yes Yes Yes Yes Yes
Observations 3,129 3,129 7,097 7,097 7,097 7,097
Adjusted R2 0.699 0.694 0.575 0.578 0.508 0.510
t statistics in parentheses

p < 0.05, p < 0.01, p < 0.001

54
Table 4. Absolute Changes and Prediction Error in VSTOXX Index on Settlement
Days. Column (1) presents the OLS regression of absolute ve-second percentage changes of the
VSTOXX index on dummy variables for each ve-minute interval during the settlement days. The
sample consists of the settlement days from January 2014 to August 2015. Column (2) shows
the OLS regression of prediction errors of the VSTOXX index using EURO STOXX 50 as the
predictor on dummy variables for each ve minute interval. Prediction errors are calculated using
ve-minute rolling OLS regressions of VSTOXX on EURO STOXX 50 index. The sample consists
of the settlement days from March 2015 to August 2015. Reported t-statistics in parentheses are
clustered by settlement date in column (1).

(1) (2)
Abs. Pct. Changes Abs. Prediction Error
11:05:00-11:09:59 -0.0135 -0.000148
(-3.43) (-2.44)
11:10:00-11:14:59 -0.0129 -0.000125
(-3.57) (-2.05)
11:15:00-11:19:59 -0.0115 -0.0000762
(-3.12) (-1.17)
11:20:00-11:24:59 -0.0116 0.0000233
(-3.72) (0.30)
11:25:00-11:29:59 -0.0128 -0.0000168
(-5.50) (-0.26)
11:30:00-11:34:59 0.0491 0.000472
(4.78) (4.58)
11:35:00-11:39:59 0.0354 0.000360
(4.12) (3.25)
11:40:00-11:44:59 0.0455 0.000492
(3.87) (4.57)
11:45:00-11:49:59 0.0569 0.000492
(3.19) (4.31)
11:50:00-11:54:59 0.0491 0.000399
(2.64) (4.08)
11:55:00-11:59:59 0.0362 0.000479
(3.02) (4.50)
12:00:00-12:04:59 -0.00411 0.000226
(-1.03) (2.37)
12:05:00-12:09:59 -0.0157 -0.000140
(-4.58) (-2.25)
12:10:00-12:14:59 -0.00590 -0.000110
(-0.52) (-1.76)
12:15:00-12:19:59 -0.0162 -0.000134
(-4.12) (-2.23)
12:20:00-12:24:59 -0.0206 -0.000156
(-6.27) (-2.33)
t statistics in parentheses

p < 0.05, p < 0.01, p < 0.001

55
Table 5. Liquidity and Market Size of SPX Options and VIX Derivatives. This table
compares the liquidity and market size of the lower-level SPX options and upper-level VIX deriva-
tives. Panel A shows the summary statistics for spread between the VIX values calculated from
SPX options bid and ask prices (VIXB and VIXA respectively) at the market open of settlement
days from January 2008 to July 2015. The spread is winsorized at the 2.5% level at each end. Panel
B shows the summary statistics for the bid-ask spread of the VIX futures with less than ninety days
to maturity from January 2008 to July 2015. Panel C shows the average ratio of the amount of Vega
of VIX derivatives exposed to the settlement relative to the total Vega traded in the SPX options at
settlement, from January 2008 to April 2015. The Vega of the VIX derivatives is calculated as the
sum of the Vega of open VIX futures and in-the-money VIX options. The Vega of SPX options is
the sum of the Vega of all the SPX options traded at settlement, computed using the Black-Scholes
model.

Panel A: Spread between VIX-Ask and VIX-Bid at Open after Settlements

Variable Mean Std. Dev. P10 P50 P90
Spread 1.55 1.289 0.46 1.08 3.73
Percentage Spread 6.80 3.54 3.07 6.05 12.47

Panel B: VIX Futures Bid-Ask Spread

Variable Mean Std. Dev. P10 P50 P90
Futures Spread 0.071 0.055 0.05 0.05 0.1
Futures Percentage Spread 0.32 0.16 0.17 0.29 0.51

Panel C: Ratio of VIX Derivatives Vega Notional to Traded SPX Options at Settlement
Variable VIX Futures VIX Options VIX Futures and Options
Equally Weighted 5.7 7.3 13.0
Value Weighted 4.7 6.3 11.0

56
Table 6. SPX Options Price Movements on Settlement Days. This table shows the changes
in the price of SPX options on settlement days from before the market opens to right afterward.
For each SPX option included in the settlement, four dierent prices are calculated: price before 8
am (average price between 7:45 and 8 am), price around 8:15 am (average price between 8:14 and
8:16 am), price around 8:30 am (average price between 8:29 and 8:30 am), and the benchmark price
right after the market opens. The table reports the dierences between the average option prices for
each two consecutive time periods (pricet pricet1 ). Positive deviation days are those with 20bp
or greater deviation in VIX settlement and negative deviation days are those with -20bp or less
deviation. The sample consists of the settlement days from May 2010 to April 2015. (March 2013
and October 2014 are removed from the sample because SPX option series do not have quotes in
the data immediately after market open.) Reported t-statistics in parentheses are for paired t-test
of dierence in mean and are clustered by settlement date.

Positive Deviation Negative Deviation

Changes before 8 to 8:15 am 0.726 -0.0984
(3.88) (-1.04)

Changes from 8:15 to 8:30 am -0.217 0.0923

(-3.58) (2.25)

Changes from 8:30 am to Market Open -0.175 0.180

(-14.40) (2.70)

Changes from Market Open to 8:45 am -0.0163 -0.0213

(-0.29) (-0.59)
Observations 2,970 1,227
t statistics in parentheses

p < 0.05, p < 0.01, p < 0.001

57