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Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six-Month High – By Matt Moran

JAN. 18, 2017 – Today the CBOE SKEW Index (SKEW) closed at 143.43, its highest value since June 2016. CBOE SKEW Index values, which are calculated from weighted strips of out-of-the-money S&P 500 options, rise to higher levels as investors become more fearful of a “black swan” event — an unexpected event of large magnitude and consequence.

The value of SKEW increases with the tail risk of S&P 500 returns. If there were no tail risk expectations, SKEW would be equal to 100.

SKEW Jan 18 Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six Month High – By Matt Moran at vixtrade.com

The FAQ on the SKEW Index notes that –

“The price of S&P 500 skewness is inconvenient to use directly as an index because it is typically a small negative number, for example -.8, -2.3, or -4.3. SKEW converts this price as follows: SKEW = 100 – 10 * price of skewness.  With this definition, a price of -2.1 translates to a SKEW value of 121. S&P 500 options with 30 days to expiration are generally unavailable. SKEW is therefore interpolated from two “SKEW” values at the maturities of nearby and second nearby options with at least 8 days left to expiration.”

HIGHER SKEW VALUES IN RECENT YEARS

The average value of SKEW (since the beginning of its data history in 1990) has been 118.4. Prior to 2014, the highest average daily closing value in a year for the SKEW Index was 122.5, but in each of the years 2014, 2015, 2016, and year-to-date 2017, the average daily closing level for the SKEW Index was 127.5 or higher.

 SKEW since 1990 through Jan 18 Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six Month High – By Matt Moran at vixtrade.com

30 ½ YEARS — BENCHMARK INDEXES AND SPX PUT OPTIONS

For investors who wish to learn more about hypothetical long-term performance of strategies that use index options, CBOE provides more than 30 strategy benchmark indexes. Note in the two charts below that the left tail risk was higher for the S&P 500 Index than it was for two indexes that use SPX put options – the CBOE S&P 500 PutWrite Index (PUT) sells cash-secured SPX options, while the CBOE S&P 500 5% Put Protection Index (PPUT) buys out-of-the-money protective put options on the SPX Index.

3 PUT Histogram Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six Month High – By Matt Moran at vixtrade.com

4 PPUT Histogram Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six Month High – By Matt Moran at vixtrade.com

MORE INFORMATION

For more information on skew and use of options for protection and income, please visit www.cboe.com/SKEW and www.cboe.com/benchmarks.

 Demand for Disaster Protection Increases as CBOE SKEW Index Hits a Six Month High – By Matt Moran at vixtrade.com >

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Weekend Review – VIX Options and Futures – 1/15/2017

Last week VIX managed to finish the day below the 2016 closing low (11.27) twice.  If it were only Friday’s close I’d throw an asterisk in there for the three-day weekend effect, but there’s no holiday excuse for the Wednesday close of 11.26.

VIX Table Term Structure Weekend Review – VIX Options and Futures – 1/15/2017 at vixtrade.com

This past week they (whoever ‘they’ are) couldn’t get enough of February VIX Calls.  On Friday, paper bought over 60,000 VIX Feb 21 Calls for 0.49.  On Thursday, there were three block trades of over 20,000 contracts each in the VIX Feb 22 Calls paying 0.48 or 0.49.  Wednesday morning there was a purchase of 98,228 VIX Feb 22 Calls for 0.47 and on Tuesday there was a block purchase of 99,400 VIX Feb 21 Calls at 0.48.  On Monday, there wasn’t any huge action in those two strikes.  At minimum it appears one or more big traders scooped up over 150,000 of the Feb 21 and 22 Calls last week.  One side effect of this demand for VIX calls is a rise in VVIX which gained over 10 points last week, despite the drop in VIX or maybe because of the low level of spot VIX.

VVIX VIX Year To Date Weekend Review – VIX Options and Futures – 1/15/2017 at vixtrade.com

This sort of divergence showed up a few times last year, where VVIX started to move up and then VIX followed a short time later.  We will see if this pattern is repeated over the next couple of weeks.

 Weekend Review – VIX Options and Futures – 1/15/2017 at vixtrade.com >

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Five Volatility Market Lessons from 2016

To be successful in any field we all need to keep learning.  My job involves staying on top of all things index and volatility related which means I am always gaining new insights about the markets.  Looking back at 2016, VIX settled into lower levels after starting the year hitting the mid-20’s as the stock market sold off.  Despite the relatively tame behavior from VIX, there were some lessons to be learned last year.

Number 1 – Non-Fundamental Volatility Spikes

Before joining CBOE I was on the buy side with a variety of firms, mostly hedge funds.  I was fortunate to work for some wonderful mentors.  One of my first lessons was that when there’s government action that causes the markets to sell off it is often a buying opportunity.  This early lesson came before volatility was a tradeable asset, but it may be applied just as easily though selling volatility.  We are all aware of the volatility spike associated with Brexit as well as the overnight action that occurred with the election of Donald Trump to the Presidency.  The chart below shows the overnight action for the front month VIX futures and S&P 500 futures.

1 SP VIX Election Night Five Volatility Market Lessons from 2016 at vixtrade.com

 

Number 2 – Currency Volatility is Not Dead

The table below shows the average of several volatility indexes in 2015 and 2016.  Note at the top of the list are volatility indexes based on expected price action for the British Pound (no surprise) and Japanese Yen.  I think singled digit volatility bores many traders, so with the sudden increase for IV on the Pound and Yen may result in those markets getting a bit more attention in 2016.

2 Y o Y 2015 2016 Vol Indexes Five Volatility Market Lessons from 2016 at vixtrade.com

 

Before moving on, I did want to highlight the long-term history for BPVIX.  The chart below shows the high / low / average for BPVIX going back to 2007.  Note we’ve had higher levels of IV for the Pound in the past and not just in 2008.  It is very possible the higher IV may be here to stay for a while.

3 BP VIX by Year Five Volatility Market Lessons from 2016 at vixtrade.com

 

I know on the table above the EuroCurrency was at the low end as it was much higher in 2015.  I wanted to show that IV on EuroCurrency options can reach higher levels as well by showing a 10 year history below.

4 EU VIX by Year Five Volatility Market Lessons from 2016 at vixtrade.com

 

Number 3 – You Can Make Money Buying VXX

This one will probably get me some hate email, but that’s what the delete button is for.  VXX is more of a trading vehicle than a buy and hold asset.  Admittedly if you bought VXX on the last day of 2015, put it in your pocket and held it through last Friday you would be unhappy with your performance.  However, if you had been a perfect trader and exited at the 2016 high you would have turned a 48% profit.  Also, as highlighted on the chart below, an overnight position on Brexit night would have resulted in a one day return of about 24%.

5 VXX Chart Five Volatility Market Lessons from 2016 at vixtrade.com

 

Number 4 – SVXY Can Be A Better Buy Than SPX

A couple of years ago, I was speaking to a CFA chapter about buying SVXY when there is a sell-off in the stock market.  This was offered up as an alternative to buying the SPY ETF.  I got a question as to why a portfolio manager would choose to buy SVXY when they could just purchase SPY.  My response was if the stock market did not rebound, SVXY would most likely benefit from VIX and (more specifically) VIX futures moving lower.  I decided to see how SVXY did relative to SPY after the market sold off in February this year.  The chart with both benchmarked to 100 appears below.

6 SPY SVXY Five Volatility Market Lessons from 2016 at vixtrade.com

 

I wrote the paragraph above and then created this chart.  I was taken aback by the performance of SVXY from February 11ththrough the end of the year.  Do note that SVXY was hit hard around Brexit, but otherwise put up pretty good numbers relative to the S&P 500 from the market bottom in 2016.

Number 5 – How Useful SPX ATM Volatility Can Be

CBOE now lists SPX options expiring three times a week.  Typically, there are options expiring on Monday, Wednesday and Friday, but that is dependent on holidays.  The chart below shows the IV of Friday expiring SPX options for the next nine weeks.  I highlighted a couple of events on the horizon, notably Inauguration Day and the January Payroll report.  Note the IV for SPX options bumps higher just after we get our 45th President (1/27 expiration) as those options expire that morning.

7 SPX ATM IV 01062017 03032017 Five Volatility Market Lessons from 2016 at vixtrade.com

 

 

A Friendly Warning

Finally, a warning, fading volatility spikes has been a profitable method of using volatility as a trading asset for some time.  As noted above it has worked quite well for several years.  However, we have had periods of consistently elevated volatility in the past and are overdue for the next one.  I pulled out and updated my favorite long term equity market volatility chart to highlight this point.  Below is a chart of the CBOE S&P 100 Volatility Index (VXO) which has been tracking volatility using S&P 100 index option pricing for 31 years.  As I typically do for volatility index charts this represents the high low and average for each year.  Notice that even 2008 pales in comparison to what happened back in 1987.  I just want to leave everyone with the knowledge that selling volatility has worked, but make sure you are protected when the next big unknown event hits stock prices and quickly pushes volatility to higher levels.

8 VXO Long Term High Low Average Five Volatility Market Lessons from 2016 at vixtrade.com

 

Finally, thanks to all the readers we have acquired over the past five years or so.  Your feedback has made me a better instructor and market observer.  I hope to hear from more of you in 2017 at rhoads@cboe.com.

 Five Volatility Market Lessons from 2016 at vixtrade.com >

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