Earlier this month press reports showed quite a bit of worldwide apprehension over the wrangling in Washington D.C. regarding the partial government shutdown and possible U.S. debt default. What are some metrics to measure the level of apprehension in the markets?
On October 9th the well-known CBOE Volatility Index® (VIX®) hit an intraday high of 21.34, its highest intraday value since June 24, 2013. VIX estimates expected volatility by averaging the weighted prices of SPX puts and calls over a wide range of strike prices.
This week on October 15th, the CBOE SKEW IndexSM closed at 131.01, its highest value since March 2012. 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 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 150 around an average value of 115.
The FAQ on the 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.”
The two charts below show Bloomberg’s estimates for 30-day implied volatility at different strikes for SPX and VIX options. The implied volatility for some key index options that might be used for disaster protection – the out-of-the-money (OTM) SPX puts and OTM VIX calls – was higher than the implied volatility for the related at-the-money (ATM) and in-the-money (ITM) index calls. Bloomberg’s estimates of 30-day implied volatility included 23.3 for 10% OTM SPX puts and 14.5 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 hit its 19-month high on October 15th.
Related to the VIX Options skew chart above, here are recent daily closing values for the CBOE VIX of VIX (VVIXSM) Index that show some big moves –
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 three volatility indexes — (1) the new CBOE Short-Term Volatility Index (VXSTSM), (2) CBOE Volatility Index (VIX®), and (3) CBOE 3-Month Volatility Index (VXVSM) — to gain an understanding of expected volatility of the S&P 500 over different time periods, and can use the VVIX 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. On October 15, for example, the VIX closed at 18.66, and Bloomberg’s estimates of 30-day SPX implied volatility ranged from around 11.7 to 23.3 across various strike prices (according to the middle chart above). 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.