Black Swan Risk Intensifies

 

Earlier this week, we looked at the CS Fear Barometer.  This alternate gauge of options traders' uncertainty shows that S&P 500 traders are bidding up the value of put options.

 

While that sounds like it should be a contrary indicator, it's not.  This has proven to be the "smart money".  When the CSFB hits a high while the "common man" VIX is pricing in low volatility, stocks usually tumble afterward.

 

Disturbingly, the VIX has crumbled 15% in the past two days, while the CSFB just hit a new all-time high.  In other words, traders are paying a record high amount for 3-month protection.

 

Also concerning is another black swan-type of indicator, the SKEW index from the Chicago Board Options Exchange.

 

From the CBOE:

The CBOE Skew Index is an option-based indicator that measures the perceived tail risk of the distribution of S&P 500 returns at a 30-day horizon. Tail risk is the risk associated with an increase in the probability of outlier returns - returns two or more standard deviations below the mean.

At a normal skew level of 100, the probability of a black swam event during the next 30 days is 2.3%.

 

But the latest value of the SKEW is 130.  At that level, the probability of a black swan event is 10.4%.

 

My math may be a bit off here, but the VIX is suggesting that the S&P 500 shouldn't move more than about 5% over the next 30 days.

 

But the SKEW index suggests that there is more than a 10% probability that the move will be greater than 10%.

 

It's certainly not a perfect predictor - it jumped above 130 many times in 2005 and 2006, with nothing more nefarious than a flattening out of the uptrend in the S&P 500 as a result.  But the current high level, combined with a new record high in the CSFB and relatively low level of the VIX, suggests caution.