Black Swan Indicator at 25-year High

The CBOE SKEW index, commonly referred to as the ‘black swan’ indicator, just spiked to the highest level in the indicators 25-year history.

Is this as scary as it sounds?

What is the SKEW?

The SKEW is calculated by the Chicago Board Options Exchange (CBOE), the same exchange that publishes the VIX.

Like the VIX, the SKEW is calculated from prices of S&P 500 out-of-the-money options. The SKEW Index basically attempts to quantify the odds of a black swan event (or S&P 500 tail risk).

CBOE identifies a black swan event as a two or more standard deviation move below the mean.

According to the CBOE, the black swan risk is negligible at a reading of 100. At 115, the risk is 6%, and at a level of 135, the risk of a black swan event is 12%. On Thursday the SKEW was at 151.22.

What is a Two Standard Deviation (Black Swan) Event?

Perhaps the easiest way to understand a two standard deviation event is with the help of Bollinger Bands.

The common default setting of the upper and lower Bollinger Band is two standard deviations above or below the 20-day SMA. The current spread between the S&P 500 20-day SMA and the Bollinger Bands is around 85 points (4%).

How Accurate is the SKEW?

The chart below captures the SKEW’s track record since the beginning of 2007.

Here are a few things worth noting:

  1. The SKEW has been moving higher since 2008, and it has taken ever-higher extremes to trigger a market reaction. It stands to reason that any stock market pullback (or black swan event) will not be commensurate to the 25-year SKEW extreme.
  2. The S&P 500 almost always reacts to SKEW extremes. Either it 1) pulls back almost instantly or 2) eventually gives back several days/weeks worth of gains.

Context is Key

The SKEW extreme appeared just as the S&P 500 is approaching an important inflection zone. The September 13 Profit Radar Report stated:

There is an open chart gap at 2,035.73. I am almost certain this gap will be filled (either during a wave 4 bounce or the subsequent rally). Depending on when we get there, 2,040 is an obvious candidate for a setup. It may be too obvious and subject to some sort of whipsaw, but 2,040 is the resistance level to watch.”

Best on the SKEW, there’s elevated risk of an upcoming pullback, especially around S&P 2,040.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

S&P 500 ‘Sudden Drop’ Index at Historic Extreme

The Chicago Board Options Exchange (CBOE), the same outfit that formulated the VIX, also calculates the odds of a ‘two standard deviation decline,’ or large sudden drop. This ‘sudden drop’ index is at a historic extreme.

What is the ‘sudden drop’ index?

It’s the CBOE SKEW Index, calculated by the Chicago Board Options Exchange (CBOE). The CBOE also formulated the SKEW’s more popular cousin, the VIX.

According to CBOE, the SKEW is designed to measure the tail risk of the S&P 500.

What’s tail risk?

Tail risk is the risk of outlier returns two or more standard deviations below the mean. Some call this a ‘Black Swan’ event or simply a sudden drop.

Similar to the VIX, the price of the S&P 500 tail risk is calculated from the price of the S&P 500 out-of-the-money options.

The SKEW typically ranges from 115 to 135. Readings of 135 suggest a 12% chance of a large decline (2 standard deviations). Readings of 115 suggest a 6% chance of a large decline.

What is the SKEW’s track record?

SKEW Index data extends back to January 1, 1990. On June 20, 2014, the SKEW spiked to 143.26, the second highest level in its history.

Is this reason to worry?

The chart below plots the S&P 500 against the SKEW. The red bars highlight prior readings above 135.

Although the highest reading in the SKEW’s history (146.22 on 10/16/1998) did not have any ill effect on the market, the SKEW has been a trustworthy indicator since the beginning of the QE bull market.

According to the SKEW, the odds for a swift decline are near a historic max. However, the bearish SKEW should be balanced with the indicator that foresaw a persistent S&P 500 (NYSEArca: SPY) rally without correction months ago.

A detailed look at this truly fascination gauge is available here:

The Only Indicator That Foresaw a Persistent S&P 500 Rally with No Correction

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Indicator: Risk of ‘Black Swan’ Event is Elevated

On February 14 we highlighted a ‘big fat’ buy signal. Now we are looking at a possible ‘Black Swan’ alert. This indicator was designed to sniff out big drops and although we may not be looking at a ‘Black Swan’ sell off, it suggests risk is rising.

On February 14, I wrote about a ‘big fat’ buy signal (New Spin on Old Indicator Gives Big Fat Buy Signal).

Now this ‘big fat’ buy signal is met by an indicator that suggests elevated risk of a serious decline (‘Black Swan’ event).

Which indicator measures the odds of a ‘Black Swan’ event?

It’s the CBOE SKEW Index.

The SKEW Index is calculated by the CBOE. The CBOE is also responsible for the VIX (NYSEArca: VXX).

According to CBOE, the SKEW is designed to measure the tail risk (= risk of outlier returns two or more standard deviations below the mean) of the S&P 500.

The SKEW Index basically estimates the probability of a large decline or ‘Black Swan’ event.

Similar to the CBOE VIX or VIX Volatility Index (Chicago Options: ^VIX), the price of the S&P 500 tail risk is calculated from the price of the S&P 500 out-of-the-money options.

The SKEW typically ranges from 115 to 135. Readings of 135+ suggest a 12% chance of a large decline (2 standard deviations). Readings of 115 or less suggest a 6% chance of a large decline.

The chart below shows the SKEW readings since January 2012 and plots them against the S&P 500 (SNP: ^GSPC).

On Friday the SKEW jumped to 138.79. This isn’t the top tick (December/January saw 139.62 and 143.20), but it’s higher than 99.5% of all other readings since January 2012.

The red lines highlight that elevated SKEW readings (such as 138+) translate into limited up side potential and increased down side risk.

The SKEW is very helpful, but should be combined with other facets and forward-looking analysis.

The December 20, 2013 Profit Radar Report (Sentiment Picture) put the message of the SKEW in context with other indicators and forecasted the following:

“Bullish sentiment will catch up with stocks in January. This should cause a deeper, but also temporary correction.”

The S&P 500 and S&P 500 ETF (NYSEArca: SPY) saw a ‘deeper but temporary’ correction and price and SKEW are basically back to where they were in January.

More up side is possible as long as the S&P 500 can stay above support, but the SKEW suggests that the up side is limited and any gains to be erased eventually.

A unique analysis of another popular indicator cautions that the SKEW’s message may be valid:

MACD Did Not Yet Confirm Stocks Up Trend

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.