The SKEW Index and Stock Market Crashes:
- Despite rising global uncertainty, an indicator that tracks the potential for a Black Swan event has slipped to decade-lows
- But according to past performance, the Index has been a poor indicator of stock market volatility
- Interested in stock market volatility? Check out an introductory article on CBOE’s VIX Index
Volatility: The SKEW Index and Stock Market Crashes
The recent bout of stock market turbulence has seen volatility levels tick higher, but lack a significant surge. On the other hand, one lesser-watched index that seeks to measure the probability of tail-risk events extreme moves higher or more often lower - recently matched its lowest reading from the past decade. The SKEW Index, curated by the Chicago Board of Options Exchange (CBOE), ticked beneath 112 on May 29 – just the third such occurrence since April 2009.
The SKEW Index measures the perceived tail-risk in the S&P 500 – based on the implied volatility of out-of-the-money options, whereas the VIX considers the implied volatility of at-the-money options. “Tail risk” is the chance that an event will occur outside one standard deviation from the mean. Given how the Index is derived, it measures the slope of implied volatility – which can then be displayed as the probability of a two or three standard deviation move for the S&P 500 in the next 30 days.
That probability is then reflected within a range - typically from 100 to 150 - where a higher reading suggests the market is perceiving greater risk of a Grey Swan event. At 130, there is approximately a 10% chance of the S&P 500 making a two-standard deviation move over the next thirty days – while the probability of a three-standard deviation move is just 2%.
Although it attempts to gauge the market’s view on tail-risk and financial crashes, it does not provide insight on whether a statistically anomalous event will actually take place. Further, SKEW is a poor indicator of stock market volatility according to historical performance – especially with the Black or Grey Swan events it tries to forecast. Since 2000, the 5-largest single-day draw downs for the S&P 500 had average SKEW reading of 113.53 the day before the decline.
Thus, the SKEW Index provides little value when attempting to gauge these extreme sell-offs. It does however, offer insight on investor sentiment. Like the VIX, SKEW can display heightened levels of investor fear – even without a simultaneous drawdown in price. That said, the notably low reading on May 28 is concerning as the S&P 500 continues to slide – while option traders see little chance of a crash, so much so that it may suggest complacency. For other equity analysis, follow @PeterHanksFX on Twitter.
--Written by Peter Hanks, Junior Analyst for DailyFX.com
Contact and follow Peter on Twitter @PeterHanksFX
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