Let’s first review the definition of the SKEW index.
The CBOE Skew Index- referred as “SKEW”- is an option-based indicator that measures the perceived tail risk of the distribution of S&P 500® lndex 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.1
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 sizeable left tail. This makes it riskier than a normal distribution with the same mean and the same volatility. SKEW quantifies the additional risk.1
While the above chart is from the CBOE page, the concept still holds over a much broader time period.
Source: Michael Harris, medium.com
While the Volatility Index (VIX) measures the market’s expectation of volatility over the next 30 days, the SKEW index focuses on the probability of a severe (large drawdown) event.
As the chart from SSgA above illustrates, expected market volatility expectations are at 20-year lows while the expectation of a large drawdown (as measured by SKEW) remain quite high. Is another bear market around the corner? This data shows it just might be.
Are you and your client’s prepared for a bear market?
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1 Chicago Board Options Exchange (CBOE)
Disclosure:
An investment cannot be made directly in an index.
This material is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument, nor should it be construed as financial or investment advice.
S&P is a registered trademark of Standard & Poor’s Financial Services, LLC (S&P), a part of
McGraw Hill Financial, Inc.
The CBOE Volatility and Index (VIX) are registered trademarks of Chicago Board Options Exchange, Incorporated. All index names of the Barclays indices are trademarks of Barclays Bank PLC.