VIX Misbehavior Leads Exchange to Fine Trader $1.28 Million

(Bloomberg) -- Suspicion has been swirling for years that something fishy is going on with Wall Street’s benchmark index for stock volatility. Now, regulators have brought fines in the space, though they may not be the smoking guns critics expected.

Cboe Global Markets Inc., which owns the VIX, fined high-frequency trading firm Akuna Securities LLC $1.28 million for improper trades in options that are used to set the price of the index. The firm neither admitted to nor denied the allegations in a disciplinary action announced Friday.

John Harris, Akuna’s chief operating officer and chief financial officer, declined to comment. Akuna’s website describes the firm as “a proprietary trading firm specializing in derivatives market-making and sophisticated modeling with a commitment to cutting-edge technology.”

While allegations of VIX-related funny business come in different varieties, including flat-out rigging to influence the futures market, Akuna’s transgression didn’t amount to manipulation in Cboe’s view. The exchange has rules that are brought to bear when that’s suspected, but they weren’t used here.

Though famous as a barometer of fear in the market based on prices for S&P 500 options, the VIX has another life as a benchmark for futures contracts that have ballooned in popularity among hedge funds and other institutions. Billions of dollars of the instruments are traded each month by professional speculators with a view on how volatile U.S. stock prices will be. Others use VIX futures to hedge portfolios in equities.

Traders’ Suspicions

The fine pertains to auctions used to settle the VIX and set a reference price for those futures, a procedure that came under scrutiny last year after traders complained about settlement values they saw as suspicious. During the auctions, tens of thousands of S&P 500 options change hands, many by market makers looking to replicate expiring futures with a similar set of options -- a “strip,” in Wall Street parlance -- to maintain an existing hedge.

That’s where Akuna was said to run afoul of Cboe’s rules. According to Cboe, Akuna entered orders three times between November 2016 and November 2017 that effectively ensured trades that wouldn’t ordinarily be included in the auction became part of its calculation.

In a separate settlement, UBS Securities LLC was cited for placing orders into auctions held between September 2015 and March 2016 that shouldn’t have been included because they were either too early or too late, according to Cboe. The firm agreed to a $135,000 fine without admitting guilt. Cboe didn’t accuse UBS of market manipulation.

A company representative declined to comment.

Professor’s Research

Suspicions the VIX is rigged have circulated for years, something Cboe has repeatedly denied. In 2017, University of Texas Professor John Griffin released research that identified problematic trading in the auctions. Cboe disputed his findings. After his report came out, trading got even more eye-catching, leading Griffin to worry his research was being used as a how-to guide for cheating.

Superficially, the Akuna case sounds similar to scenarios outlined in Griffin’s allegations. However, the price of the VIX barely budged as a result of Akuna’s actions, leading to only $6,726 in ill-gotten profits that the firm was asked to give back.

Akuna’s motivation, according to a person familiar with the exchange’s findings, was to use the auction to move its market hedge from one set of contracts to another. To do that, Akuna entered orders to artificially ensure certain S&P 500 contracts would be included in the process, thus perfectly replicating its hedge.

The problem with that is that Cboe wants market forces, not a single firm’s strategy, to dictate which contracts are included in the VIX auctions -- hence the almost $1.3 million fine aimed at discouraging the behavior.

“Cboe does not tolerate rule violations and responds with appropriate disciplinary action as warranted,” it said in a statement. The decisions announced Friday related to violations of “rules pertaining to just and equitable principles of trade, supervision and disruptive practices,” but not Cboe Options Rule 4.7, which is “related to manipulation.”

U.S. markets regulators have been investigating the VIX auctions. Last year, Cboe announced several enhancements to how the auctions work, saying unusual price swings seen in the index were the result of too few traders participating in the events. The changes were pitched as a way to bring more traders in. Auctions since then have been less eventful.

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