The median of the daily closing values of the CBOE Volatility Index® (VIX®) so far this year has been 13.7, which is below the long-term median value of 18.3 for the VIX since 1990. The fact that the VIX lately has been below its long-term median has led some people to ask whether there now is too much complacency in the markets. However, in the charts below, the SKEW Index and the SPX volatility skew could suggest that some investors are not complacent at all, and there is strong demand for out-of-the-money (OTM) protective puts on the S&P 500® (SPX) Index.
This past Friday (June 20) the CBOE SKEW Index rose to 143.26, its highest level since Oct. 16, 1998.
CBOE SKEW Index values, which are calculated from weighted strips of out-of-the-money S&P 500 options, rise to higher levels as investors become more fearful of a “black swan” event — an unexpected event of large magnitude and consequence. The value of SKEW increases with the expected tail risk of S&P 500 returns. If there were no tail risk expectations, SKEW would be equal to 100. Historically, SKEW has varied in a range of 100 to 147 around an average value of 115.
The FAQ on the CBOE SKEW Index notes that –
“The price of S&P 500 skewness is inconvenient to use directly as an index because it is typically a small negative number, for example -.8, -2.3, or -4.3. SKEW converts this price as follows: SKEW = 100 – 10 * price of skewness. With this definition, a price of -2.1 translates to a SKEW value of 121. S&P 500 options with 30 days to expiration are generally unavailable. SKEW is therefore interpolated from two “SKEW” values at the maturities of nearby and second nearby options with at least 8 days left to expiration.”
CNBC recently posted a new blog on the “Back Swan” Index.
VOLATILITY SKEW CHART
The chart below shows Bloomberg’s estimates for 30-day implied volatility at different strikes for AAPL, USO and SPX options. The implied volatility for some key index options that could be used for disaster protection fr stock portfolios – the out-of-the-money (OTM) SPX puts – was higher than the implied volatility for the related at-the-money (ATM) index options. Bloomberg’s estimates of 30-day implied volatility included 21.1 for 10% OTM SPX puts and 9.9 for ATM SPX options. The fact that the SPX chart below had such a negative slope was closely related to the fact that the CBOE SKEW Index recently hit its highest point in more than a decade.
HOW CAN INVESTORS USE THE SKEW AND VOLATILITY INDEXES?
The VIX and other volatility indexes can be very valuable tools for investors, as the indexes are well-known, numerical gauges that show changes in expected volatility over time. Investors can now use a number of volatility indexes — (1) the new CBOE Short-Term Volatility Index (VXST), (2) CBOE Volatility Index (VIX), and (3) CBOE 3-Month Volatility Index (VXV) — to gain an understanding of expected volatility of the S&P 500 over different time periods, and can use the VVIX Index for expected volatility of the popular VIX Index.
However, none of these volatility indexes gives investors much information regarding the fact that implied volatility can vary across different strike prices. The CBOE SKEW Index can provide valuable information and signals to investors above and beyond the information supplied by the VIX Index. The SKEW Index could be helpful to both hedgers and traders in identifying times in which OTM SPX puts are relatively expensive compared to ATM options. The SKEW Index could be a valuable informational tool to investors who are considering engaging in the vertical spread strategy, an options trading strategy with which a trader makes a simultaneous purchase and sale of two options that have the same expiration dates and same underlying security but different strike prices. Hedgers who contemplate the purchase of SPX OTM protective puts can use both the VIX and SKEW indexes to gain a better idea of the relative cost of the strategy.
The CBOE SKEW Index provides valuable historical and up-to-date information to investors and hedgers, and can serve as a great complement to the CBOE’s volatility indexes. More information and price history is at www.cboe.com/SKEW.