How expensive are out-of-the-money (O-T-M) index put options that could be used for portfolio protection? This is a big issue for many investors.
Two indexes that investors could use to help gauge the relative cost of O-T-M index puts over the past 23 years are the CBOE Volatility Index® (VIX®) and the CBOE SKEW Index (SKEW). As shown in the chart below, in the past week the SKEW Index topped 130 for the first time since last September. www.cboe.com/SKEW
BACKGROUND ON THE SKEW INDEX
The CBOE SKEW Index is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options.
Here are key stats for the SKEW Index since the inception of its data in Jan. 1990 –
- High 146.2
- Low 101.2
- Average 117.0
A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the “skew”.
SKEW CURVE POST-1987
The SKEW white paper available at www.cboe.com/SKEW notes that —
“Since it emerged from a smile in the wake of the crash of October 1987, the curve of S&P 500® implied volatilities, a.k.a. the smile or “skew”, has been one the most studied features of S&P 500 option prices. As illustrated in Chart 1, the smile has lost its symmetry and it is biased towards the put side.”