Last Friday the Chicago Board Options Exchange SKEW Index rose to its highest level since 1998:

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Skew

 

What is SKEW you might ask?

From the CBOE website:

"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, SKEW would be equal to 100. Historically, SKEW has varied in a range of 100 to 147 around an average value of 115."

To summarize, when investors expect there is a greater probability of a large magnitude downside event in the market, they bid up out-of-the-money S&P 500 put options - thereby causing the SKEW Index to rise.

Is a high SKEW Index predictive of anything? The short answer is NO. The last time the SKEW was this high (October 1998) the market rallied in the subsequent weeks, and before the 2008 crash the SKEW was not at an especially high level. However, it is worth noting that it is rather unusual for the SKEW to be so high while both implied & realized equity volatility remain near historic low levels (in October 1998 the VIX was above 30).

Normally the SKEW Index will rise to high levels when investor fear rises amid periods of elevated market volatility. This is what makes the current market environment so unique; an extremely high SKEW against a backdrop of extremely depressed levels of market volatility. This is certainly something to pay attention to over the coming weeks and investors would be wise to mind the SKEW......