Someone Playing With the VIX Settlement?

• Posted by Adam Warner
• on August 19th, 2010

The August VIX expired yesterday on the open. The CBOE has a description of the settlement procedure here.

The Final Settlement Price for VIX Futures is determined from a Special Opening Quotation (SOQ) of VIX. The SOQ is calculated from the sequence of opening prices of the SPX options used to calculate the VIX index on the settlement date (the “Constituent Options”). The opening prices for SPX options used in calculating the SOQ are determined through an automated auction mechanism (“Hybrid Opening System” or “HOSS”) that matches buy and sell orders residing on the Electronic Order Book prior to the opening of trading. If there is no opening price for a Constituent Option, the average of that option’s bid price and ask price as determined at the opening of trading is used instead. The settlement date for VIX futures is the Wednesday that is thirty days prior to the third Friday of the calendar month immediately following the month in which the contract expires (“Final Settlement Date”). The VIX White Paper provides specific information on the VIX calculation.

It’s important to distinguish the VIX open by this definition from the first VIX price you see on the board. The VIX settlement bases on the first print in each actual SPX option that goes into the calculaiton. The VIX itself can *open* whenever the CDOE decides to start calculating it. So if they *open* VIX at 9:31, it may base on just a few SPX series, i.e. many SPX series will ultimately factor into the VIX settlement have not even opened yet.

Why bring this up? Well check out the graph above of the first half hour of VIX yesterday. VIX itself actually *opened* at 24.33. August VIX settled at 24.81. That’s a ginormous disparity. If you were short VIX futures or VIX calls, you got completely hosed.

As we noted yesterday in the VIX Sonar post, the order flow in VIX on Tuesday aroused suspicion. August VIX options traded much of the day as if the settlement would run up 50-75 cents. Well guess what, it happened. It just transpired in an odd way, it looked like a non-event at 9:30 then by 9:33 the VIX had lifted 50 cents.

Now in the actual market, they print all sorts of worthless SPX put series. I spoke to VIX Sonar Jamie about it, and he points out these are real options orders, not crosses. And in fact SPX Sept puts printed all the way down to the 600 strike. So the buyer of the strip (the package of the SPX options) presumably owns the Aug. VIX future and gets cashed out on that end.

All this leaves me with many questions. Feel free to throw on answers to any of these

Is the SPX strip buyer short Sep. VIX in some way against it? What does he do with the SPX options he owns, in order to replicate actual VIX, don’t you need to roll them slightly each day to keep 30 day duration?If in fact there’s only one side on the SPX strip order, doesn’t this get the crowd way short SPX premium in September?

And why in Fast Times at Ridgemont High does Damone tell Rat to play “Led Zeppelin IV, Side 2″, and then in the car Rat’s actually playing a song that’s not on that album (Kashmir).

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