Tail-Risk Hedges Spike To Record High

While VIX declined last week, the cost of protecting against major market swings has spiked above its previous Brexit-vote-day peak, reaching a fresh all-time high.

As a reminder, CBOE explains, SKEW, 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. 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".

By way of example, Adam Johnson (@AJInsight) explains: "Investors are SO SCARED… They're paying 6x more for out-of-the-$ puts than calls $SPY 4-247c $0.09 $SPY 4-227p $0.55"

As Bloomberg reports, with the Federal Reserve raising borrowing costs and the political environment remaining uncertain, the CBOE SKEW Index climbed for five straight days, its longest streak since June 2016. The last time the gauge of out-of-the money S&P 500 Index options prices was as high relative to the volatility gauge, the VIX surged 65 percent in the next month.

Both of the previous two SKEW spike events (Brexit and 2015's Fed rate hike) saw a market plunge… immediately followed by a miraculous melt-up from coordinated global central bankers. With Trump in command, will those central bankers, led by The Fed, be quite so accomodating this time around?


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