Investors are inquiring about the cost of hedging as the S&P 500 (SPX) Index hit its all-time monthly closing high value of 2003.37 last Friday, and we are entering the historically volatile months of September and October
In the Aug. 30 Striking Price Column in Barron’s, Steve Sears wrote —
“… Investors are increasingly discussing what it means that the CBOE Volatility Index (VIX) is historically low while bearish put prices are expensive. … Stephen Solaka, a partner with Belmont Capital, a Los Angeles money-management firm, is advising clients interested in hedging stocks to use a ‘put spread collar.’ …”
After reading Mr. Sears’ comment on “bearish puts are expensive” I developed the two updated charts below that show that there indeed appears to be high demand for out-of-the-money protective index puts.
CBOE SKEW INDEX – HIGH LEVELS IN 2014
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 and concerns, SKEW would be close to 100.
The average daily closing levels for the CBOE SKEW Index were –
> 129.6 in 2014 (through August)
> 117.2 in the 24 years from 1990 through 2013.
Since the beginning of the SKEW time series in 1990, nine of the fourteen highest daily closing levels for the CBOE SKEW Index have occurred in 2014.
VOLATILITY SKEW FOR AAPL, USO, AND SPX OPTIONS
The graph below shows Bloomberg estimates for different slopes for the volatility skews for 30-trading day implied volatilities for AAPL, USO and SPX. For the at-the-money options, the implied volatilities are 24 for AAPL and 9.3 for SPX. For the options at 90% moneyness, the implied volatilities are 27.1 for AAPL and 19.7 for SPX.
HOW TO USE THE SKEW INFO
The CBOE SKEW Index and the Volatility Skew graph can provide valuable information and signals to investors above and beyond the information supplied by the VIX Index. The SKEW Index and Volatility skew graph could be –
(1) helpful to both hedgers and traders in identifying times in which OTM SPX puts are relatively expensive compared to ATM options.
(2) valuable informational tools 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.
(3) Valuable to hedgers who contemplate the purchase of SPX OTM protective puts; the SKEW Index and Volatility Skew graph can help hedgers to gain a better idea of the relative cost of the strategy. As suggested in the recent Striking Price column, investors could consider the put spread collar strategy.
More information on the CBOE SKEW Index is at www.cboe.com/SKEW.
DISCUSSION AT RMC EUROPE
At the CBOE Risk Management Conference Europe this week in Ireland (1) Mr. Sears will participate in a panel discussion on Sept. 3, and (2) on Sept. 4, Natasha Jhunjhunwala, Equity Derivatives Product Management, Credit Suisse, and Sheldon Natenberg, Co-Director of Education, Chicago Trading Company, will deliver presentations on The Volatility Surface: Skew and Term Structure. www.cboermc.com.