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Forget The VIX: SKEW Tells The True Story About Hedging Market Risk

Tyler Durden's picture




 

Once again retail is getting duped into believing that all is well in the market by daily blasts of just how low the VIX has plunged. And it has: it is down to levels not seen in years. But as everyone who has done even a little work in option vol, the only index that matters these days, at least for equities now that precious metals and certain currencies (CHF) are the true flight to safety, is the SKEW. As we have disclosed many times in the past, SKEW is how the pros play vol, while VIX is what is left for the peasantry and CNBC. Basically, VIX shows riskiness as implied by ATM options, while SKEW demonstrates the difference between ATM and OTM options. And as the chart below shows, there is a rather dramatic difference when looking between the VIX and SKEW indices. In essence what is happening is that everyone is selling ATM short-dated vol and buying mid-term Out of the Money vol as expressed by the SKEW, in a confirmation that the protection cost in the wings is actually much higher than one would assume.

For those still confused, this is how it was described previously:

The chart below shows this quite clearly as VIX (At-the-money vol) ebbs away (red arrows) as the day-to-day vol of more 'normal' mark-to-market movements is culled thanks to the liquidity fueled effervescence, the rise in out of the money (or crisis/event risk) vol has risen dramatically (white arrows). This can only go on so long as vol arbitrageurs will creep up the moneyness curve (to hedge the tail risk) and eventually impact the ATM. This happened in early 2010 and is happening again currently.

The recent moves in the major credit indices also fits with this world view as any smarter-than-the-average bear capital structure arbitrageur knows that the skew (and specifically the out of the money vol market) has a much better relationship with credit than the near-the-money. One other potential way to think of this (hattip to Artemis recent article on this) is that the skew better represents the real market value of the Bernanke Put (i.e. how much is the market pricing in the never-ending story of a Fed-provided safety net) - perhaps notable that the SKEW began to rise very shortly after Jackson Hole and the QE2 plan came online.

Needless to say, the SKEW does not paint a remotely as rosy picture as does the VIX.

Lastly, another index you will never hear about is the Credit Suisse Fear Barometer, presented on the chart below.In a nutshell: "The CS Fear Barometer measures investor sentiment for 3-month investment horizons by pricing a zero-cost collar.  The collar is implemented by the selling of a 10% OTM SPX call option and using the proceeds to buy an OTM put.  The CSFB level represents how far out-of-the-money that SPX put is.  The higher the level, the greater the fear."

Paints quite a different picture than the VIX doesn't it?

 

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Tue, 04/19/2011 - 14:47 | 1185077 Catherine007
Catherine007's picture

http://content.usatoday.com/communities/theoval/post/2011/04/obama-to-re...

 

Well Obamaaaaa looks very tired - battled out man?? Hahahah

Tue, 04/19/2011 - 14:50 | 1185080 I think I need ...
I think I need to buy a gun's picture

well little timmy was on this morning and he said he was going to save the middle class and that made me feel so much better

Tue, 04/19/2011 - 14:50 | 1185083 RobotTrader
RobotTrader's picture

The PigMen are trying their hardest to paint nipple bottoms everywhere.

Today, they are gunning for a "tradeable low" on KRE.

Perhaps another "Extend and Pretend" or "Mark to Fantasy" edict is forthcoming out of Sheila Bair?

Tue, 04/19/2011 - 14:58 | 1185112 Muir
Muir's picture

"The PigMen are trying their hardest to paint nipple bottoms everywhere."


 

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Your poetry is lost on most of the peasantry, Robo.

 

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But take heart, poetry it is. 

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Tue, 04/19/2011 - 15:04 | 1185123 QE4EVER
QE4EVER's picture

Forget the banks; Chinese inter-web names with little to no revenue generation are a license to print currency...

DANG break-out and continuation today, MOBI (Chinese Facebook and Apple app store), PWRD, QIHU and YOKU...

When the SPX breaks 1343, and given that it is all but pre-ordained to do so, these are going up 5x-10x on the way to SPX 1500-1600...

But don't worry, silver and gold will still net you 10%-20% runs as well haha...

Tue, 04/19/2011 - 14:50 | 1185085 SheepDog-One
SheepDog-One's picture

'Retail getting duped'...you cant mean Robotrader! He loves caressing his daily retail stock boner chart, and saying things like-

'The market is not pricing in QE3 it is pricing in a massive consumer-lead recovery'

Tue, 04/19/2011 - 15:07 | 1185142 Dick Darlington
Dick Darlington's picture

Gotta love that, lol.

Tue, 04/19/2011 - 15:12 | 1185154 Dick Darlington
Dick Darlington's picture

Gotta love that, lol.

Tue, 04/19/2011 - 14:51 | 1185087 SheepDog-One
SheepDog-One's picture

Watch out for that Apple, Robo! Full of maggots. Warnings of 50% drop offs in IPads, etc. Not too good!

Tue, 04/19/2011 - 14:53 | 1185092 carbonmutant
carbonmutant's picture

Damn, Skewed Again...

Tue, 04/19/2011 - 14:53 | 1185093 Muir
Muir's picture

"there is a rather dramatic difference when looking between the VIX and SKEW indices. In essence what is happening is that everyone is selling ATM short-dated vol and buying mid-term Out of the Money vol as expressed by the SKEW"

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Fat tails, bitchez!

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Tue, 04/19/2011 - 15:31 | 1185259 reload
reload's picture

This has been a tried and tested strategy since the late 1980`s in the Forex market. A big move and boom, you are a hero. In those days traders exploitd less sophisticated `risk management` from their overlords and could take big positions this way slightly off the radar. IIRC this was the way Andy Krieger at Bankers trust became so legendary. Anybody remember him? last I heard (probably 20 years ago!) he had become a recluse on a Greek Island.

Great article TD, thanks for reminding me of the significance of the SKEW.

 

 

 

Tue, 04/19/2011 - 15:42 | 1185329 Mercury
Wed, 04/20/2011 - 07:11 | 1187330 projectxland
projectxland's picture

reload - not junking you on Andy Krieger as he definitely had the rep but 1 year after he left BT - they had to restate option p/l by $80m ...also interesting that some journos trying to dig deeper into what John Key (current pm) knew about the collapse of the kiwi in 87...

Tue, 04/19/2011 - 14:55 | 1185094 RobotTrader
RobotTrader's picture

More Nipple Bottoms posted here:

Could be a fakeout, but who knows?  Gotta play it just in case.

http://clearstation.etrade.com/cgi-bin/bbs?post_id=9704276

Tue, 04/19/2011 - 14:56 | 1185099 RobotTrader
RobotTrader's picture

RE:  AAPL

Tough call.

They are ramping it to suck people in.

Tue, 04/19/2011 - 15:11 | 1185158 SheepDog-One
SheepDog-One's picture

LOL, on zero volume. Stench of desperation everywhere.

Tue, 04/19/2011 - 14:54 | 1185100 joebren
joebren's picture

I still think VIX works pretty well as a contrary indicator.

Tue, 04/19/2011 - 15:03 | 1185132 topcallingtroll
topcallingtroll's picture

Mean reversion is very robust, but who would have thought it could drop so low? Those who tried to buy.volatility at all the logical times probably didnt do so well.

Tue, 04/19/2011 - 16:07 | 1185474 chunkylover42
chunkylover42's picture

pretty much.  flip it upside down if you want to get a better sense of how "risky" the market is.

Tue, 04/19/2011 - 14:57 | 1185101 Beatscape
Beatscape's picture

Fascinating.  I did not know about the SKEW index.  Seems a better way to track volatility: "SKEW demonstrates the difference between ATM and OTM options".  Good work, Tyler.

Tue, 04/19/2011 - 19:53 | 1186250 slewie the pi-rat
slewie the pi-rat's picture

thanks.  i got upset looking for the VIX chart. 

Tue, 04/19/2011 - 14:59 | 1185107 LawsofPhysics
LawsofPhysics's picture

Blah blah blah, what is the trade?

Tue, 04/19/2011 - 15:02 | 1185119 topcallingtroll
topcallingtroll's picture

Risk off

Tue, 04/19/2011 - 15:30 | 1185258 Beatscape
Beatscape's picture

The trade has been to sell ATM put options on equities--volatility is being squashed.  It's been working just fine.  Just be aware of the coming cataclysm and cover these in a hurry if a 8.x earthquake hits California.

Equities have survived 3 ME revolutions, a biblical tsunami in the world 3rd largest economy, "headline" inflation, downward revisions to US GDP, a double-dip in US housing prices... The Phed will just keeping printing to make it all okay.  The Zimbabwe stock market will keep rising along with PMs.

Tue, 04/19/2011 - 14:58 | 1185117 topcallingtroll
topcallingtroll's picture

My underwear is.giving me the code brown alert.

It is always a little early but the big money now seems to be preparing for a correction and some risk off.for a while.

Like i said if the correction is anticipated.for the end of qe2 along with return of deflationary fears, then it will probably happen a little earlier.

Wed, 04/20/2011 - 07:06 | 1187315 projectxland
projectxland's picture

best technical indicator description - luv it!

Tue, 04/19/2011 - 15:02 | 1185124 Long-John-Silver
Long-John-Silver's picture

I found RobotTrader on youtube. Now I understand him perfectly, including his attraction to women with large breasts.

 

http://youtu.be/iDmJcDvaBGU

Tue, 04/19/2011 - 15:02 | 1185130 gordengeko
gordengeko's picture

Would be curious to see if short interest is picking up.

Tue, 04/19/2011 - 15:05 | 1185131 Sudden Debt
Sudden Debt's picture

It's already complicated enough for a simple retail trader like me :)

My explorer is already filled with shortcuts of dozens of indicators and I only use them to follow up. Not the make decisions for purchases. Not that I even made any these last 3 months.

The bullion is all I care for these last few months.

 

Tue, 04/19/2011 - 15:03 | 1185134 The Axe
The Axe's picture

Tyler thank you very helpful..

Tue, 04/19/2011 - 15:15 | 1185167 jkjacksonhole
jkjacksonhole's picture

How do i chart SKEW with stock charts? it does not recognize the symbol

 

Tue, 04/19/2011 - 15:17 | 1185173 Dollar Bill Hiccup
Dollar Bill Hiccup's picture

That's a good one.

So the market is going up in inverse correlation to fear which is inversely correlated to the VIX since ATM options are like the Eternal Sunshine of the Spotless Mind while the Skew reveals the squirming lizard brain, alive and kicking in the top 1% of wealth holders who work so hard at stealing wealth from all of the other 99% of the populace that they are terrified of losing one dime and will gladly pay up to protect their asses (did I miss a "t" there?). What if Bennie gets hit by a brick or falls off of a horse or is found on a park bench with a note and a hole in his head?

Tue, 04/19/2011 - 15:20 | 1185208 No Bid
No Bid's picture

SKEW didn't respond to the Japanese nuclear situation, the biggest story on this site for the last month.  VIX did.  

Tue, 04/19/2011 - 15:22 | 1185219 buzzsaw99
buzzsaw99's picture

when you're a maggot billionaire, with a a deficient moral code, your sense of right and wrong, fair and unfair will always be tragically SKEWed...

 

[/Fat Bastard]

Tue, 04/19/2011 - 15:57 | 1185358 Cdad
Cdad's picture

Tyler,

You forgot to mention the VXX and VXZ creation units machines...and how they allow criminal syndicate Wall Street bankers to sell infinity shares in risk.  Those machines, btw, should be pretty near to meltin' down at this point.

Or....maybe that is exactly what your story says.   Hmmmmmm?

Fuck it, goin' back down my cosmic bunny hole with the gnomes 'cause I cannot figure what the hockey helmet wearin' kid standing in the center of the NYSE floor clapping for himself [aka S&P] is thinking while barbarous metals go to all time freakin' highs right before folk start tradin' ounces for ammunition.

Good grief [and by that I mean when are those NYSE boys going to put the mouthguards in?]

Tue, 04/19/2011 - 16:07 | 1185475 Mercury
Mercury's picture

That's VXX and VXZ.  Both have been great shorts!

Wed, 04/20/2011 - 06:33 | 1187288 ZeroPower
ZeroPower's picture

Hence the reverse splits.

Wed, 04/20/2011 - 03:41 | 1187166 Burnsy
Burnsy's picture

Have a look at the mutual fund cash levels as of feb this year. Noone left to buy size if this market starts selling off.

 

http://home.comcast.net/~RoyAshworth/Mutual_Fund_Cash_Levels/Mutual_Fund...

 

Wed, 04/20/2011 - 07:30 | 1187380 Remington IV
Remington IV's picture

Herbert Hoover

 

Jimmy Carter

 

Obama

 

.

Wed, 04/20/2011 - 09:58 | 1187807 Jim B
Jim B's picture

++

Do NOT follow this link or you will be banned from the site!