As market analysis evolved, various measures of risk have emerged. The metric about which we hear most often within the financial media is the “Volatility Index”[4] – quite often referred to as a “Fear Index”. It is in this context that, with all due respect to the financial media, I suggest that the CBOE SKEW Index is a more effective and helpful metric through which to track either risk or fear.

According to the CBOE, SKEW is an option-based metric designed to measure the perceived risk of “outlier” returns within the window of the following 30 days – with “outlier” referring to returns that are more than two standard deviations below the mean.  Expressed in simpler terms, it is designed to measure the perceived risk of a nearby stock market tumble or crash. Now that is what I call a risk metric!!

 

Eoin Treacy's view

Looking at the CBoE’s SKEW Index one might ask what exactly is going on. On August 24th the S&P 500 pulled back very sharply and the Index tells us this was a surprising event for the options market because traders had not, on aggregate, initiated hedged positions ahead of it. Since then the Skew rallied substantially, particularly in early September, as fears of an additional drawdown predominated. 

The Index hit an all-time high last week and has since pulled back somewhat suggesting that those who did not have short positions six weeks ago are now taking the market rally as an opportunity to take out the insurance they wish they had in August. 

Depending on one’s perspective this is either a contrary indicator of traders trying to close the barn door after the horse has bolted or it suggests traders want some protection before initiating additional long positions following what has been an impressive rally to date. 

Of three potential areas of resistance following the August drawdown i.e. the roundophobic 2000 level, the region of the 200-day MA and the lower side of the overhead range, the S&P 500 Index has cleared one and is now testing the second. The SKEW Index tells us the speed of the drawdown has had an effect on sentiment which supports my view the drawdown has similarities with the 2010 flash crash. Against a short-term overbought condition there is scope for some consolidation but the Index has ample scope to do so following what has been an impressive rebound.