TraderJoe wrote:...Whats up with the 'SKEW'??? It's way, way up...
High SKEW just indicates that the “pros” are loading up on portfolio insurance, as they “should” with the market so near its highs.
RISING SKEW = RACE TO BUY PUT PROTECTION AND SELL CALLS = HEDGING
OLD NOTES TO SELF: [from various sources]
$SKEW is essentially the relationship between the “implied volatility” of SPX out-of-the-money puts to comparable out-of-the-money calls.
Institutional/professional investors are the biggest traders in SPX options. The pros hedge their exposure to tail risk (risk of crash, black swan risk) by purchasing SPX puts with low strike prices (OTM puts). This shift in demand bids up the prices of these puts relative to their value under a normal distribution.
As the pros become more concerned about the potential for a market decline, 'crash protection' is in demand, and the SKEW rises, reflecting the higher relative premium they are willing to pay to hedge. They start rotating from 'normal' risk protection to 'extreme' risk protection.
Basically a 'low VIX/high SKEW' combination says that: "the market overall is complacent, but the pros perceive far more tail risk than usual.“
SKEW is a good way of estimating investor hedging appetite, since it varies independently from the level of implied volatility.
Why is skew is so high?
Option market sentiment:
1) Low demand from call buyers (bearish)
2) High supply of call sellers (bearish; pros are willing to forgo the upside potential in favor of downside protection)
3) High demand of put/protection buyers (bearish)
In June, as the market was correcting, the pros loaded up on portfolio insurance. By the time SKEW registered its highest (June 28-29 SKEW hit the highest on record, approximately 153.36), it marked a SPY bottom. At a certain point, most extremes become contrary indicators. With such extremely negative market sentiment, contrarians thought a SPY bottom was near, and sure enough, SPY hit rock bottom for that cycle.
WHAT IS SKEW:
http://www.cboe.com/micro/skew/documents/SKEWFAQ.pdf