CSFB Fear Barometer - Why is fear stable?

 

There have been significant discussions about fear and uncertainty in the current marketplace, but it seems that to get a true idea of fear is to look at what is going on with market prices. Talk is cheap. Following action is more valuable. 

An innovative approach to measuring the action from fear is through the CSFB Fear Index which looks at the pricing of a zero cost collar on the SPX index. The index measures the premium of a 10% out of the money call and then finds percentage out of the money strike for a put on the SPX index that would make the combination a zero cost collar. 

If there is more fear, then an investor would only be able to buy a put further out of the money with the call premium. The fear index value would go higher. If the index falls, this fear barometer is telling the market that you can buy protection closer to at the money with the premium from the call writing. Since the index is pricing a zero cost collar, this index will account for any skew in option prices.

The current index levels are surprisingly stable over the last month in spite of the market sell-off. Even with election uncertainty, the fear index has been stable. The index is much lower than summer levels. The maximum fear was in February before the March liquidity crisis. Fear was actually at its lowest levels in March.

The long-term index shows that fear has declined from highs in 2016. The index is still elevated versus pre-GFC, yet the trend has been lower. It is interesting that fear has been growing or high for most of the period of equity gains. Fear and price moves have an interesting link that does require further study. Given the complexity of the relationship between equity index returns and fear, this index has not been given much attention, yet it provides a unique assessment of market opinion. 

Currently, the option collar is saying we have less need for worry. It is unclear why options have this relatively higher optimism.