Extreme skew in the market - the cost of tail hedges

 

Markets may move higher but that does not mean that invetsors are more optimistic about any equity trend. In fact, current information on risk perceptions shows that there is significantly greater fear of a left tail event as meaasured by the CBOE skew index. Like the VIX index, the CBOE uses prices from equity index options to calculate the skew embedded in market prices across the traded strike for an implicit one month option. The skew number usually falls between 100 and 150 but current values are at extreme levels.

The high skew suggests that buying put ptrotection is more expensive versus any period since the inception of the index. The value is higher than any period associated with business cycle downturns or market crashes. The risk-adjusted probabilities below provide the orders of magnitude for skew.  A 155 reading is off the charts for both a two and three standard deviation event. It is time to be careful given the market's view on risk.