CBOE Skew vs. VIX

Today, I would like to speak about the convergence and divergence between the SKEW and the VIX. I guess that everybody is familiar with the VIX that reflects a market estimate of future volatility (introduced in 1993 by the Chicago Board Options Exchange – CBOE, measures the 30-day volatility implied by the ATM S&P500 option), however let me introduce you to the CBOE SKEW index.

Since the crash of October 1987 (Black Monday, DJ down 22.6%), investors have realized that S&P500 tail risk (returns that are under 2 or more standard deviations below the mean) is significantly greater than under a lognormal distribution. Therefore, the ‘skew’ measures the perceived tail risk of the market via the pricing of OTM options. A rise in skew indicates that ‘crash protection’ is in demand among institutional investors (also called the ‘big players’ in the SPX options market).
A ‘low VIX/high skew’ combination says that the market is complacent, however the ‘big players’ perceive far more tail risk than usually. Therefore, a surprise increase in realized volatility may not be too far away.

If we have a look at the chart below (which represents in fact the VIX and the SKEW), we can see that VIX (green) is sitting at very low levels at the moment (13.57%) and may need to release some ‘energy’. In blue, we have the Skew index which has been fluctuating within the 125 – 130 range for the past few weeks (now trading at 129.25). I recommend you closely watch your positions when the index is approaching the high of the ‘historical’ 100 – 150 range.


(Source: Bloomberg)

If you extend the historical chart since 1990, you can see that the perception of increased tail risk can be early (skew was above 130 level in 2005 already while the VIX was trading at 10.0 at that time), but it definitely remains one the ‘fear’ indicators watched by Wall Street players (with CSFB – Credit Suisse Fear Barometer – index).

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