The claim sounds dubious: the VIX, that index at the center of the stock market's wild gyrations over the past week, is somehow being manipulated.
That allegation, made to federal authorities by an anonymous whistle-blower, captivated Wall Street on Tuesday, prompting both quick dismissals and more than a few raised eyebrows.
Cboe Global Markets Inc., the Chicago-based owner of the VIX, said the idea is preposterous. Many traders agree. Yet after the burst of volatility and the three swings of more than 1,000 points in the Dow Jones Industrial Average last week, some are asking the question: What if?
The allegation has prompted second thoughts in no small part because global finance has a record of trying to manipulate all sorts of things, including benchmarks for interest rates and currencies. What's more, it's not the first time someone has raised questions about whether the VIX is being gamed.
"It's always been an ongoing conversation," said Jim Strugger, a derivatives strategist at MKM Partners. With the meltdown of some VIX-related products last week, "obviously, there is more focus now. If there is proof of manipulation, that would be another huge blow for the vol space."
An academic study last year purported to show the VIX settlement is subject to manipulation. Last month, Cboe also fined a Chicago-based trading firm following allegations it submitted improper bids to volatility auctions for emerging-market stocks and oil.
The Financial Industry Regulatory Authority, an industry funded watchdog, has increased its scrutiny of VIX trading, according to a person with knowledge of the matter. Cboe has an agreement with the regulator to monitor trading on its markets. It's not clear at this point whether there is a formal investigation by Finra, which is overseen by the U.S. Securities and Exchange Commission.
The Wall Street Journal earlier reported that Finra was examining whether prices linked to the Vix have been manipulated.
Cboe and Finra spokesman Ray Pellecchia declined to comment.
There's plenty at stake. Exchange-traded funds and notes tied to the VIX are worth about $3.5 billion, according to Bloomberg Intelligence analyst Eric Balchunas. Hundreds of thousands of futures contracts are in circulation, and are popular with hedge funds and other institutions.
Beyond that, there's the issue of financial-market stability. Some traders believe the wild session on Feb. 5 -- when the U.S. stock market suddenly went into a freefall before quickly recouping some of its losses -- could've been fueled by VIX products.
In a letter on Monday to the nation's top markets regulators, the whistle-blower's lawyer said that "unethical" market makers were whipping the VIX around without putting any money on the line, earning hundreds of millions of dollars a month in ill-gotten profits.
A flaw lets manipulators put in bogus quotes on S&P 500 Index options, which determines the value of the VIX, to opportunistically move it in one direction or another, the letter said. The client, who wasn't identified by name, has held "senior positions at some of the largest investment firms in the world," according to the client's attorney, Jason Zuckerman of Zuckerman Law.
Bill Speth, Cboe's head of research and one of the people who redesigned the VIX in 2003, said Tuesday the letter contains "a lot of mistakes and a lot of misconceptions."
Market forces would probably stamp out any attempts at manipulation, he argued. If a rogue trader tried to sway the VIX by putting in questionable S&P quotes, arbitragers would quickly move in to profit from the discrepancies and move prices back to where they should be, Speth said. And practically speaking, the level of the VIX -- it's just an index that you can't actually trade -- matters less to traders than the prices of the derivatives tied to it.
"If you talk to any trader who's actively involved in the VIX, you know that nobody pays attention to the spot value," he said. "There have been a number of times where the VIX futures and options have operated seamlessly in the complete absence of a VIX spot level."
Mark Sebastian, managing partner at Option Pit in Chicago, is also skeptical.
"I think their claims are dubious," he said. "You'll see the VIX make moves that are strange, but I've never seen VIX futures actually react to VIX distortions."
Several other market pros also pooh-poohed the letter's specific allegations and cited some basic errors of understanding (like incorrectly saying VIX futures trade on CME Group Inc.'s exchange, rather than on the Cboe). But they say it's called attention to legitimate concerns about VIX manipulation, specifically during the settlement auction of VIX futures contracts.
In May, researchers at the University of Texas published a paper in which they found evidence the settlement process was being gamed, possibly by people holding derivatives.
The authors, John Griffin and Amin Shams, likened their account of VIX gamesmanship to Libor and currency markets, where traders allegedly manipulated fixings to maximize profits on instruments they held. That study got more traction after an unusual trading session on Dec. 20, when the VIX dropped just as billions of dollars of futures were set to expire, possibly earning money for short sellers.
"People might be concerned that individual players could move the settlement," said Pravit Chintawongvanich, the head of derivatives strategy at Macro Risk Advisors. "It is a legitimate concern."
The next monthly settlement occurs today.
Cboe vehemently denied the paper's conclusions, and Speth said the authors didn't consider the full range of possible reasons other than manipulation that could explain the moves they observed.
Nevertheless, the exchange's safeguards haven't been perfect, which suggests Cboe isn't immune to being gamed. The exchange fined DRW Securities LLC, a unit of Don Wilson's big Chicago-based trading firm, in January for alleged misconduct in settlement auctions for Cboe's emerging-market stocks and oil indexes. DRW neither admitted to nor denied the allegations as it paid a penalty of about $1.5 million. Cboe said it couldn't comment on the case.
Those aren't the VIX, but DRW's alleged actions might illustrate how Cboe indexes can be moved around. The exchange found that nine times in 2014 and 2015, DRW submitted options trades that artificially expanded the number of orders included in the settlement auction.