Turbulence isn't something most passengers look forward to when boarding an airplane. And the spike in our internal fear gauge while passing through a rough patch is likely activated by our natural instinct to survive.
As it relates to financial markets, a burst of turbulence at 30,000 feet isn’t a bad analogy for intensifying anxiety that the market may be poised for a sell-off.
However, a recent installment of Options Jive highlights some historical data that suggests increases in market anxiety may be much like turbulence in the friendly skies - most instances pass relatively uneventfully.
While the VIX is one popular gauge of market of market fear/anxiety, the Skew Index provides additional insight.
Skew is a term used in the financial marketplace that explains why puts generally trade at a higher price than calls - assuming all else is equal. This concept can be observed through the market price for volatility, as downside puts will almost always trade at higher levels than upside calls (note: like any "rule" there are exceptions).
While we know skew exists by looking at the options market, skew is also measured more formally. The Skew Index essentially measures the degree of skew observed in the marketplace.
Simply stated, as put buying intensifies relative to calls, the Skew Index rises.
For reference, the Skew Index incorporates a scale from 100 to 150 to measure the perceived likelihood of a two standard deviation move in the S&P 500. A reading of 100 indicates that trading activity is fairly balanced in terms of call and put buying. On the other hand, a reading of 140-150 indicates that put buying has intensified significantly as compared to call buying.
Interestingly, data presented on Options Jive reveals that the average 45-day move in SPY hasn’t historically been that much more pronounced when the Skew Index is elevated, as compared to lower levels.
This analysis supports the notion that much like turbulence, rising anxiety over an impending sell-off doesn’t mean that it will actually materialize.
The numbers below illustrate the respective average 45-day moves in the SPY when the Skew Index is above/below 140:
Skew Index > 140: 1.5% move in SPY
Skew Index < 140: 1.0% move in SPY
Previous research conducted by the tastytrade financial network reinforces these findings.
On a past installment of Market Measures, a study was presented (using data from 2005 to present) that showed selling 30 delta puts when the Skew Index was >135 actually produced a higher win rate than executing the same strategy in all environments. Another key finding from this study was the fact that the average loss was also lower when selling puts with the Skew Index above 135.
This information, combined with your own evaluation of risk and opportunity in today's market, may help you identify further opportunities in your portfolio.
If you have any questions about the Skew Index we hope you'll leave a comment below or send an email to firstname.lastname@example.org.
Thanks for reading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.