Can the Government Manipulate the VIX?

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I saw someone pose a question on StockTwits this morning asking if there is any way the U.S. government can manipulate the CBOE Volatility Index (VIX) to artificially lift the market.

Forget about whether you think the government manipulates securities prices in general. To answer this question, I will put on my Zero Hedge commenter hat (I’m not actually a commenter for that blog, or a reader, for that matter) and say they do.

The answer is, of course they could. In fact, anyone could.

Want to know how you can “manipulate” the VIX?

You would have to do something radical like � buy some near-term puts on the S&P 500. Yes, believe it or not, that’s basically all the VIX measures. It’s an index of volatility on SPX options normalized to 30 days duration.

The government, or an average-size hedge fund, could spend a few million dollars and pay up for some puts. It would lift implied volatility across the board for a short time, with the chance of the elevated volatility persisting if it caused a chain reaction.

In fact, The Wall Street Journal ran a piece on May 10, speculating whether a large put purchase by a hedge fund connected to (gasp) Nassim Taleb helped bring on the “flash crash.” The allegation was baseless on the surface, but the basic gist is actually different from the above. The put buy itself caused the chain reaction, not whatever it might have done to a volatility index.

And that brings me to my point: The VIX is a statistical measure, and it reflects (and quantifies) market sentiment; it does not cause market sentiment.

For example, saying “The VIX breaking above 30 reflects apprehension in the market,” makes sense. Saying “The VIX breaking above 30 caused apprehension in the market,” does not.

Of course, some people see a rising VIX and get nervous, but it’s quite a stretch to believe they were idling along as if nothing was happening, and then all of a sudden got terrified at some magical VIX level.

Which brings up another point: It’s overwhelmingly likely that VIX broke above 30 thanks to a weak market. So what did the VIX tell you that you couldn’t infer anyway? The answer in this narrow case is nothing.

So, to answer the original question, there are a lot of things to worry about out there. The government buying or selling some SPX �puts to influence a volatility index is hardly one of them.

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