Since we first exposed (and explained) [5]the Black-sh Swan-link nature of the options market's Skew Index, the mainstream media has lept to various conclusions (from ignore it, like everything else, to 'wow'). However, what is crucial to comprehend is that the soaring Skew is occurring at the same time as a collapsing VIX.
And stunningly, what we have seen over the last two days is somewhat unprecedented - VIX has continued to collapse into option expiration (and we know the pattern that occurs after opex [6])
[7]
...as SKEW has soared to new all-time record highs.
[8]
As a reminder, Skew measures the perceived tail risk of the market via the pricing of out-of-the-money options
Generally, a rise in skew indicates that 'crash protection' is in demand among institutional investors (institutional/professional investors are the biggest traders in SPX options).
What this looks like to us is a managed collapse of VIX (that is at-the-money-ish options volatility) which signals to the mainstream that all is well and is levered to drive stocks higher into option expiration (as we have seen above 8 times in a row) while at the same time buying deep-out-of-the-money options to maintain a hedge (of extreme moves).
In other words, professionals have rotated from 'normal' risk protection to 'extreme' risk protection at the largest pace on record all the while fooling the mainstream investor who sees a declining VIX and continues to pick up pennies in front of the steamroller.
As we explained previously, [9]
An
unusual move in the skew index (which historically oscillates
approximately between a value of 100 and 150) is especially interesting
when it diverges strongly from the VIX, which measures at the money and close to the money front month SPX option premiums.
[10]
Basically what a 'low VIX/high skew' combination is saying is: 'the market overall is complacent, but big investors perceive far more tail risk than usually' (it is exactly the other way around when the VIX is high and SKEW is low).
In other words, a surprising increase in realized volatility may not be too far away... and with OpEx looming, we suspect today or Monday will be the day.
