When the CBOE Volatility Index® (VIX®) drops below 14 (as it did in recent days), we sometimes hear questions such as – Is there still strong interest in portfolio hedging with index options?
One metric that shows relative demand for out-of-the-money S&P 500® (SPX) put options is the CBOE SKEW Index (SKEW), with a daily price history that begins in 1990. Prior to 2014, the highest average daily closing value in a year for the SKEW Index was 122.5, but in each of the years 2014, 2015 and 2016 (through Nov. 17) the average daily closing level for the SKEW Index was 127.5 or higher.
The average daily closing values in 2016 (through Nov. 17) were 127.9 for the CBOE SKEW Index (see the table above), and 16.3 for the VIX Index (see the table below).
CBOE SKEW INDEX
The levels of the CBOE SKEW Index indicate increased demand for out-of-the-money (O-T-M) SPX puts during the past couple of years. The average daily closing levels of the CBOE SKEW Index have been — (a) 118.4 since its start date in January 1990, and (b) 129.8 in 2014 (the all-time high for any year).
On Nov. 3, 2016, the SKEW Index hit 141.18, its highest level since June 2016.
The value of the SKEW Index increases with the 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 101.2 to 153.66. The FAQ on the SKEW Index notes that – “The price of S&P 500 skewness is inconvenient to use directly as an index because it is typically a small negative number, for example -.8, -2.3, or -4.3. SKEW converts this price as follows: SKEW = 100 – 10 * price of skewness. With this definition, a price of -2.1 translates to a SKEW value of 121. S&P 500 options with 30 days to expiration are generally unavailable. SKEW is therefore interpolated from two “SKEW” values at the maturities of nearby and second nearby options with at least 8 days left to expiration.” www.cboe.com/SKEW.
VOLATILITY SKEW FOR SPX OPTIONS
The volatility skew charts below show that Livevol’s estimates for SPX implied volatility were quite a bit higher for SPX options at 80% and 90% moneyness when compared with SPX options with moneyness at 100.
DISCUSSION OF HIGHER SKEW LEVELS IN U.S.
In a December 2015 Bloomberg news report – “Who’s the Bear Driving Up the Price of U.S. Stock Options?” – Joseph Ciolli wrote – “For more than a year, dealers in the U.S. equity derivatives market have noted a widening gap in the price of certain options. If you want to buy a put to protect against losses in the Standard & Poor’s 500 Index, often you’ll pay twice as much as you would for a bullish call betting on gains. New research suggests the divergence is a consequence of financial institutions hoarding insurance against declines in stocks.”
At his comprehensive presentation at the First Annual CBOE Risk Management Conference (RMC) Asia in Hong Kong a year ago, Buzz Gregory of Goldman Sachs discussed skew and noted that -- (1) The skew for the S&P 500 is the highest of any major market in the world, and (2) The S&P 500 skew may remain high because of regulatory pressure on big banks to hedge big downside risks. Regulatory initiatives include – (a) Comprehensive Capital Analysis Review (CCAR), an annual exercise by the Federal Reserve to assess whether the largest bank holding companies operating in the United States have sufficient capital to continue operations throughout times of economic and financial stress, (b) Dodd-Frank Act stress testing is a forward-looking component conducted by the Federal Reserve and financial companies supervised by the Federal Reserve to help assess whether institutions have sufficient capital to absorb losses and support operations during adverse economic conditions.
POSSIBLE INVESTMENT IDEAS RELATED TO HIGHER SPX SKEW LEVELS
If you expect that the SPX skew levels will be relatively high in upcoming months or years, what are some options strategies that an investor might consider? One of the most straightforward strategies to consider would be the sale of O-T-M cash-secured SPX put options. To learn more, please visit the Strategies and Education tabs at www.cboe.com.
Qualified institutional investors also are welcome to register at www.cboermc.com for an upcoming Risk Management Conference hosted by CBOE –
* RMC Asia 2016: Nov 30 – Dec 1, 2016 at the Conrad Hong Kong Admiralty, Hong Kong
* RMC US 2017: Wednesday – Friday, March 8 – 10, 2017 at the St. Regis Monarch Beach, Dana Point, California.