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Waiting to be SKEWered?

October 15, 2015

Waiting to be SKEWered?

SKEW Goes Pear-Shaped

Back in 1998, at the height of the Russian crisis, the CBOE SKEW Index reached its all time high of 146.88. Previously very high values were seen on the eve of the 1990 recession, and in March 2006 it spiked again when sudden worries about the housing bubble surfaced.

Black-Swan lr“There are no black swans” they said …

Over the past two years, SKEW has begun to act totally crazy, regularly rising to rarely before seen levels. In late 2014 and again in September this year, moves to around the 140 level have become quite frequent. On Tuesday it broke its Russian crisis all time high, spiking briefly to 148.91.

SKEWSKEW spikes to a new all time high on Monday – click to enlarge.

“What the hell is SKEW?” we hear you ask. Here is the explanation from the CBOE, where SKEW lives (or rather, where the options that are used in its calculation live):

“The CBOE Skew Index – referred to as “SKEW” – is an option-based indicator that measures the perceived tail risk of the distribution of S&P 500 log returns at a 30- day horizon. Tail risk is the risk associated with an increase in the probability of outlier returns, returns two or more standard deviations below the mean. Think stock market crash, or black swan. This probability is negligible for a normal distribution, but can be significant for distributions which are skewed and have fat tails. As illustrated in the chart below, the distribution of S&P 500 log returns has a sizable left tail. This makes it riskier than a normal distribution with the same mean and the same volatility. SKEW quantifies the additional risk. 

SKEW is derived from the price of S&P 500 skewness. That price is calculated from the prices of S&P 500 options using the same type of algorithm as for the CBOE Volatility Index (VIX). The details of the SKEW algorithm and a sample calculation are presented in the SKEW White Paper http://www.cboe.com/SKEW .

 

 

…click on the above link to read the rest of the article…

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