Investors Say They Were Harmed by Manipulation in Volatility Products

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Investors Say They Were Harmed by Manipulation in Volatility Products

A trader works in the Cboe Volatility Index pit on the floor of the Cboe Global Markets building in Chicago in February. Photo: Daniel Acker/Bloomberg News

A group of investors filed a complaint against Cboe Global Markets Inc. CBOE -1.84% on Friday, alleging that they experienced losses because its popular volatility products were manipulated.

The complaint alleges that market players consistently manipulated prices of derivatives tied to the VIX—a widely watched volatility measure that is also known as the Cboe Volatility Index. The investors claim that Cboe, which operates the largest options exchange in the U.S., knew about the activity, according to the complaint filed in the Northern District of Illinois. The proposed class-action lawsuit needs a judge’s ruling in order to proceed.

“Cboe designed, then regularly administered for profit, a fatally flawed process,” the lawsuit says. “As a result of CBOE’s malfeasance, the prices for VIX options and VIX futures have been subject to wholesale manipulation.”

A spokeswoman for Cboe declined to comment on the complaint. The Chicago-based company has previously said that trading alleged as irregular is consistent with normal activity and not evidence of manipulation. It has also previously said it regularly monitors for nefarious activity and takes disciplinary action when warranted.

The VIX is calculated using options prices on the S&P 500 index. It tends to rise when stock prices fall and has hence become a popular way for investors to hedge other holdings or bet on future turbulence in the market. A whole ecosystem of products that allow investors to wager on the VIX has emerged, including futures and options contracts that have turned into a lucrative business for Cboe.

But claims that the VIX is manipulated have cropped up in recent years. And the gauge became the center of widespread attention in February when two exchange-traded products tied to it collapsed.

In recent years, as share prices continuously rose, some of the ETPs, which trade like stocks, had become a way for investors to bet volatility would stay low—known in the market as the “short vol” trade. That came to a head in February as volatility spiked in U.S. equities, triggering losses for “short vol” investors across Wall Street and Main Street.

In the lawsuit filed Friday, investors take issue with a regular auction operated by Cboe, which determines the prices of VIX futures. The investors allege they were harmed when the auction distorted trading and made the prices of VIX futures and options “artificial.”

The complaint also claims price tampering of such derivatives affected trading of the VIX ETPs.

Some in the options industry have told The Wall Street Journal that unusual activity in the monthly auction could be driven by investor hedging as opposed to any nefarious activity.

Cboe has made moves to change its monthly auction to boost trading since February.The exchange operator has tried to reduce some of the anomalous pricing that has occurred on days VIX futures contracts expire. Cboe recently filed a proposal with the Securities and Exchange Commission to make changes to the auction. The proposal requires regulatory approval.

Cboe shares were once thought of as a beneficiary of higher volatility, since turbulence in markets could lead to more trading of its products. But the once highflying stock is down 23% in 2018, even as shares of other exchange-operators have rallied this year.

Write to Gunjan Banerji at [email protected]