What if the only thing we have to fear isn’t fear itself but rather how we measure it? That’s been the concern lately about the Cboe Volatility Index®—often referred to by its pithy acronym, VIX®, but arguably better known as the fear gauge.
Why “fear”? Because the VIX attempts to measure the market’s 30-day implied volatility assumption by tracking the implied volatility of short-dated options. And why the concern about the VIX? Because from many investors’ perspective, funny things have been happening lately with the index—not ha-ha funny but strange funny.
For example, as was widely reported in the media, the VIX jumped nearly two points during the open auction period on April 18, the day VIX options and futures were set to expire. According to a follow-up letter issued by Cboe, the primary driver of the change was a buy order submitted during the auction for approximately 212,000 S&P 500® Index options across a wide range of strikes that caused an order imbalance. The result was a leap in the price of the options and thus the level of the VIX.
To hang some numbers on it, a derivatives broker estimated that the two-point change in the price of the index resulted in a $200 million change in P&L of expiring VIX options and futures. The order, submitted only five minutes prior to the 9:20 a.m. opening-auction cutoff, originated from a single market participant. This event comes on the heels of an academic publication by John Griffin and Amin Shams (both from the University of Texas at Austin) that claims to find evidence of manipulation of the VIX at settlement.
So what’s going on here? Is someone manipulating the VIX? Does it affect the broader S&P 500® options market from which the VIX is derived? What should investors do? Let’s begin by understanding the scope of the VIX market.
How big is the VIX?
As you can see from the chart below, since 2010 open interest in VIX futures has nearly tripled.
VIX Futures Open Interest
Source: Cboe. Date range represents the inception date of the VIX futures, and open interest figures represent end-of-day numbers. For informational purposes only and not to be used for investing purposes. Not an offer to buy or sell securities.
Potential Parametric Solution
We manage over $17 billion in investment strategies that seek to capture the volatility risk premium (VRP), a well-researched return premium evidenced by the discrepancy between the implied and realized volatility of equity index options, the very options used in the construction of the VIX. Parametric has developed a series of sophisticated VRP strategies in an effort to meet different investor objectives.
Tom Lee, CFA, Managing Director, Investment Strategy & Research
Mr. Lee leads the investment team that oversees investment strategies managed in Parametric’s Minneapolis and Westport Offices. In his current position, Tom directs the research efforts that support existing strategies and form the foundation for new strategies. He is also chair of the Investment Committee that has oversight of these strategies. Tom has co-authored articles on topics ranging from liability driven investments to the volatility risk premium. Prior to joining Parametric in 1994*, Tom spent two years working for the Federal Reserve in Washington, D.C. He earned a B.S. in Economics and an MBA in Finance from the University of Minnesota. He is a CFA charterholder and a member of the CFA Society of Minnesota.
*Reflects the year employee was hired by The Clifton Group, which was acquired by Parametric Portfolio Associates® LLC on December 31, 2012.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.