Making Sense of the 'Black Swan' Indicator at All-Time Highs

The CBOE SKEW Index (SKEW) is at all-time highs, suggesting traders are willing to pay up to hedge against tail risk

Oct 15, 2015 at 8:42 AM
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While we were sleeping ... the SKEW index hit all-time highs? What's SKEW? I don't know -- what's SKEW with you? (I'll be here all night. Try the veal!)

OK, sorry, it's just that I find it impossible to type "SKEW" without adding a terrible joke. Here's the Chicago Board Options Exchange (CBOE) quick description:

"The CBOE SKEW Index ("SKEW") 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. SKEW typically ranges from 100 to 150. 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."

The CBOE SKEW Index (SKEW) is essentially the relationship between the implied volatility of S&P 500 Index (SPX) out-of-the-money (OOTM) puts to comparable OOTM calls. The higher the number, the higher the SKEW -- that is to say, the higher relative premium investors/traders are willing to pay to hedge against tail risk. Over the course of time, SKEW looks like this, per CBOE:


Basically, a big blue blob in a slow uptrend over the last seven years. More recently, however, it has spiked to new highs:

Chart courtesy of

What's it all mean? Historically, not a whole lot. Dana Lyons has a great write-up on the topic that I can't do justice with one clipped 'graph. But here's that 'graph:

"The average level of the Skew last year was far above any other year since the Skew's inception in 1990. This persistently high Skew for so long, along with the cluster of Skew extremes above 140 might understandably make one skeptical of the indicator's usefulness as a tail risk warning. That's because, outside of the October 2014 selloff, there has been precious little in the way of stock declines following these recent high readings. And while there has been limited intermediate-term upside following these readings, there has certainly been no black swan event."

This makes some sense, intuitively. In regards to low SKEW, the CBOE says that means "the probability of outlier returns is therefore negligible."

No. That means the marketplace is assigning a low probability of the outlier. Likewise, of course, high SKEW means the marketplace is assigning a high probability.

Why is that different? The CBOE assumes it says something about the probability of the actual event happening. Rather, it's the market's perception of that probability. And markets are often wrong. Sentiment tells are more often contra-tells than predictive tells. It's exactly the same principle as a high CBOE Volatility Index (VIX) reading. At times it proves prescient; but way more often than not, it's a sign that fear has gone too far.

Like VIX also, it's a tool that quantifies actual "bets" with actual money. And if those bets lean too far one way, it's not uncommon to see those bets go bad. If nothing else, it implies natural buyers into weakness.

I do like it as a tool to augment VIX. In fact, it's going to tend to give you signals at times VIX doesn't. That's because high SKEW will tend to show up at times of lower VIX. When VIX is high, you're just not going to see excessive bid up in OOTM puts vs. calls. The question is whether we can read anything into those signals, and I'd agree with Dana Lyons' conclusion that the results are mixed.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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