A 21% Chance Of A 50% Plunge In The S&P 500?

Tyler Durden's picture

Investors' perceptions of risks, both normal (volatility) and tail (event), have intriguingly run to both extremes at the same time. 'Normal' volatility has been so suppressed by Central-Bank action as to become an almost useless indicator (or at best contemporaneous) - or as Artemis Capital notes "volatility has become a shadow currency" with the USD (safe-haven) becoming considerably more correlated with volatility. Extreme volatility concerns are where the 'unintended' consequence has appeared. In a somewhat stunning market realization, options markets currently suggest a 1 in 4.7 chance of a greater-than-50% drop in the S&P over the next year. That is more likely than the lifetime risk of a heart attack. The question then is, are tail-risks over-priced? Or are investors willing to overpay for that kind of 'deflation' insurance since we now know that the impossible is possible!

 

[look at the skew of the distribution of returns since 2008 - the light blue section - show upwardly biased it has become...]

 

and through time... the chart below shows the chart above through time, and the rise in extreme tail risk pricing since the crisis began...

 

Source: Artemis Capital Management