SKEW And You

• Posted by Adam Warner
• on February 11th, 2011

Tired of laboring comparing two numbers on an SPX options board and dividing one by another? Fear not, the CBOE will now do it for you! This, from CNBC.

Investors looking for Black Swans in the stock market may be able to find them in the latest offering from the Chicago Board Options Exchange.

On Feb. 23, the CBOE plans to roll out the S&P 500 Skew Index, an options gauge that already has earned the monikers of both the Black Swan Index and, a bit more derisively, the SIX.

At its heart, the SKEW (as the CBOE prefers) will measure out-of-the-money S&P 500 options to determine the risk of unanticipated, or Black Swan, events threatening the market. The Black Swan reference, of course, is from the Nassim N. Taleb book of the same name that, in part, delineates the importance of low-probability but catastrophic events in financial markets.

The SKEW will measure the implied volatility between puts and calls and derive a numeric value from the difference between the two.

Well I guess this will look at more than 2 strikes. But its not going to yield an enormously different result from doing something simple like taking a call premium that’s X% away from the money and dividing it by a put that’s also X% away. Or just looking at a skew chart that’s available on ivolatility or LiveVol.

But whatever, it can’t hurt to have more info indexed in a more accessible format. Its generally going to tell the same story as VIX though. Remember that VIX incorporates all sorts of OTM puts, so looking at SKEW on top of VIX sounds very redundant. If OTM puts are flying, so will VIX.

And also, as my friend notes, “Since the whole point of Taleb’s work is that “Black Swan” events have no probability distribution (i.e., they are one-offs), how can one construct an instrument that attempts to assign such things a probability?”. Of course he’s right, you can’t, though the market will try.

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