S&P Options Making Room For Possible Downside

Tyler Durden's picture

The weird and wonderful world of options markets and models can sometimes provide useful insights on a reflexive/contrarian basis if we know where to look. Everyone is used to reading/hearing about VIX (Pisani's Fear Index) which tracks a near-the-money relatively short-dated implied volatility (note upside and downside volatility not just downside - though volatility and price do tend to co-depend quite highly). There are many other 'implied' distributional measures one can glean from the broad array of liquid options prices.

By comparing the normal (or log-normal) assumptions from simple options models with traded market prices for options, sophisticated investors can get a grasp for how different the market's view of the forward-looking distribution of prices looks relative to a normal distribution.

Two of these are Skewness - how biased to the left (downside) or right (upside) the distribution is expected to be and Kurtosis - how fat the tails of the expected distribution are (how much more likely extreme non-normal moves are).

Short- and long-term skewness implied by the options markets has begun to drop (rise in the chart) which implies a skew more to the right and less to the left - or a lower chance of downside risk. This shift reflects options participants reducing hedges for downside.

Long-term kurtosis has dropped notably (as the risk of extreme moves or fat-tails shifted from a longer-term to shorter-term stressor. While short-term kurtosis remains relatively high (fat-tails are still a concern), it has started to drop very recently as investors pull back on their hgedges of extreme moves.

The actual skew in options implied volatility has also dropped as we crashed in August - makes perfect sense as those that were betting on a nasty downside surprise or hedging, have taken profits or reduced their hedge as a degree of comfort comes back into the market.

While VIX has dropped, implied correlation (another options implied measure) remains very elevated. The implied correlation measures the difference between what the index options imply and what the aggregation of the underlying components of the index imply - if correlation was 1 between every pair of names in the S&P 500 then S&P index implied volatility would be the same as a weighted average of all the underlying options implied vols. We know that correlations rise in crash scenarios considerably more than in rising scenarios and so tracking implied correlation can offer insight into how professionals view crash risk.


This measure is extremely hard for any retail or non-hedge-fun/non-market-making desk to trade due to the number of tickets and simultaneity of the trades required (as well as the hedging program) and so when this moves, we believe it reflects professional opinion in a non-contrarian manner (i.e. retail is not involved).

As VIX has dropped from crisis levels recently, Implied Correlation has continued to rise as professionals adjust their prices for index options vs underlying single-name options to reflect this systemic risk concern.


The bottom line is that options skews have dropped (the cost of protecting significant downside has reduced relative to upside: e.g. 90%/110% SPY skew has dropped from 1.8x to 1.5x in the last 2 months), and long and short-term kurtosis (fat-tail concerns - high risk of extreme moves) has dropped recently, distributional skewness (downside tails relative to upside tails) is rising - indicating less concern over downside tail moves.

Put all of these together and it is clear that investors have swung from very anxious to more neutral and add the non-contrarian implied correlation signaling concerns over crash risk (or a high correlation event) and we are concerned.

When all of these indications are at extremes, there is little chance of an extended downside move since broad swathes of investors are hedged and hence not feeling all the pain - however, with current levels having normalized modestly, any downside shock (no QE3 for example) could easily be exaggerated by unhedged forced selling. It is somewhat contrarian but in the same way as when everyone is short we can get a short squeeze, when everyone is hedged a market will not drop as aggressively - our indications show investors are less hedged (even though Pisani will tell us the Fear Index remains elevated) and downside risk potential is high.


Charts: Bloomberg

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vast-dom's picture

Too funny! SP at 850 is generous. What levitates up on hot hopium must invariably come down.


Dem popping sounds ain't corks shooting out of Dom bottles in celebration, it's heads pulled out of asses for a 3rd 2nd wind that'll offer a hell of a lot more perspective than O2.

Dr. Engali's picture

S&P 400 is where we will find true price discovery.

rocker's picture

Scumbag Robert Prechter had a UTube vid out this weekend  and free news letter telling all that the rally is over and exhausted.

I wonder if he lost any subscribers today. I hope so. What a scumbag outfit. Cow poop smells better than his words of wisdom, (not).

SparkySC's picture

I'm starting to think Tyler Durden is in fact Mark Haines.

All the CNBC references are starting to add up.

Or sure Mark's gone from CNBC and supposedly the planet, but he just may be trading with Elvis.



I miss the voice of reason that was Haines, I mean Tyler.




RichardP's picture

Those monetizing their websites generally go for eyeballs, not reason.

SheepDog-One's picture

Last hurrah market pump and short squeeze today before tomorrows down spike on FOMC total disappointment.

baby_BLYTHE's picture

I still predict QE3 early 2012. It will come about around the same time Greece officially defaults. January 2012 is also when the Bush Tax Cuts expire and might even be the time the Buffett Tax is implemented (pending the legislation is passed). Benocide and the FOMC no doubt figure this into their calculations hoping the tax increases will yield more tax revenue for the government from the money they print and also soften the blow of the double-digit inflation it will produce. It won't work as intend of course just as the other QEs but it has never stopped them.

Mactheknife's picture

Tomorrow will be a "sell the news" moment no matter the FOMC result...unless the Bernank comes out with something totally outrageous which is probably 50/50 he just might.

rocker's picture

Reading the article, by unhedged positions and the force out of shorts it may seem that this is what they wanted all along.

Take it down hard, and afterall, they know when to push the manipulated market in either direction.

I love what one trader said on the floor. Traders buy all pull backs knowing the FED has their back. Say POMO.

And another trader said, "we should ask are we going into a recession or depression."

Coin Flip time. Heads they win, Tails they win. Either way, in the markets and your going down.

These HFTs and computer software of hedge funds can see a single dollar bill hit the market and they go after it.

ISEEIT's picture

Market disappointment isn't likely. I'm thinking Benny will announce three Fed actions. Lower interest paid on reserves. 'twist' long rates, and the bomb will be purchasing European sovereign bonds with a specific mention of Italy.

He'll achieve three much lusted for objectives.

1.) Crush USD

2.) Spike stocks

3.) reduce volatility, at least in the near term.

If I remember right it was Slovakia today that went off line. The EFSF now can't be put in place for at least 4 more months. If EUR can't be stabilized we sure as shit won't be seeing any lessening of uncertainty.

It will all blow up at some point anyway but all they appear to care about anymore is kicking the can.

Robslob's picture

This is BULLISH!

espirit's picture

What's this market going to fall on?  Good news?

This ponzi has decoupled from the rest of the world, and follows the HFT lead.

jblack010's picture

One of the more useful posts in a long time.

candyman's picture

excellent piece

spiral galaxy's picture

I'm going with my ZH contrarian play.  Bad newz...BUY!  Good newz...BUY!!  Bad & Good newz....double down BUY!!!  CNBC sez "BUY"........'SELL"!!!!...and fast!!

twotraps's picture

totally agree.  the whole thing is pathetic.  

mirac's picture

How much information is in a Bloomberg terminal?  It boggles the mind...

scatterbrains's picture

I don't know but when is the TDurden terminal hitting the market ?

wandstrasse's picture

The first two charts look a bit like Hermann Nitsch's bloodbath-'Schüttbilder'


caerus's picture

afternoon selloff...check

scatterbrains's picture

This selling I think is just the nutSack adding /ES shorts so he can reverse with buys in the middle of the night while volume/liquidity is sleeping.


horseguards's picture

Way too complex. Why not simply compare current vs historic implieds across strikes, expiries, call vs put (smirks and smiles, and all that)?

Or just look at relative premiums: if calls are higher, sentiment is bullish; if puts are higher, sentiment is bearish. This is basic supply and demand; market-makers will ramp prices in anticipation to compensate for the higher risk (to themselves) and to simply exploit/cash in on the situation.




horseguards's picture

Correction: implieds (and premiums, or premia, if your a classical scholar) need to be compared against deltas, not strikes: the delta (and premium) on a 5000 strike when cash is 5,500 will be considerably higher compared to a 5000 strike when cash is 4,500.


twotraps's picture

in the article it states that its always been a 'money' problem.  I think its really an image problem, the fed/govt/central bank community has a massive PR problem and needs to maintain the illusion that all this bullshit matters......that debts, ratios, leverage, payments, ALL MATTER.  

They have a dilemma:  How to bailout problem areas to keep the game and their control of it alive....without cheapening the process so much that people catch on.   I am not a fundamental guy, but this shit looks bad and if there is any market left whatsoever, the constant manipulation will come back to haunt you.

msmith's picture

It's amazing how buyers keep stepping in to buy this market.  The real trouble that Europe is in is no where near priced in the market and the troubles in the US will resurface because nothing has been done to solve them.  Equities will return to the lows this year and most likely head lower http://bit.ly/nlr4c9

ZeroPower's picture

Excellent post. Important to note rising volatlity is not always a sign of bearishness either (vol slowly crept higher during 06-07 bull run).