‘Black Swan’ Warning Indicator Soars to Record High

Have you even seen a black swan, I mean the actual bird? Probably not, because they are extremely rare.

That’s why the black swan has been used to describe extremely rare outlier stock market events. ‘Event’ is simply a nice way of saying crash or meltdown.

Black swan events are as rare as they are unpredictable, but the CBOE (the same outfit to create the VIX) crafted an index designed to measure the risk of a black swan event. This index is called the SKEW Index.

Here is the main difference between the VIX and SKEW: The VIX is based on implied volatility of S&P 500 at-the-money options while the SKEW is based on implied volatility of far out-of-the-money S&P 500 options.

Here is how the SKEW works: Readings of 100 mean that the risk of a black swan event is low. For every 5-point increase in the SKEW Index, the risk of a black swan event increases 1.4%.

On Friday, the SKEW Index closed at 155.31, which is the second highest reading since 1990 (as far back as SKEW data goes). A reading of 155 also means that the risk of a black swan event is 15.4% higher than usual.

With the theoretical stuff out of the way, let’s see if the SKEW Index actually works.

Does the SKEW work?

The chart below plots the S&P 500 agains the SKEW Index (going back to 1990). The SKEW moved above 150 only on 17 of 12,967 trading days (that’s 0.13% of the time). And none of those 17 days happened before 2015.

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The next chart makes it easier to identify those 17 times. Here are the key takeaways:

13 of the 16 prior signals (81%) saw any gains erased within the next 3 month

3 of the 16 prior signals (19%) saw significant further gains (2 of those gains were erased within 18 months)

Summary

The SKEW Index deserves credit for flashing warning signals prior to the 2016, 2018 and 2020 declines. It needs to be noted though that those signals were about 2 months too early. It will take a break below support to edge the potential black swan risk closer to reality.

Continuous updates are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s evaluation 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. 

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

Detailed Investor Sentiment Comparison Between 2007 and 2015

Once a month, the Profit Radar Report publishes a detailed analysis of investor sentiment (called Sentiment Picture).

The October 2015 Sentiment Picture tackled the question whether current investor sentiment is indicative of a major market top.

To find out, the Sentiment Picture provided a side-by-side comparison of investor sentiment at and leading up to the 2007 top with current sentiment.

Before we get to the 2007/2015 comparison, allow me to fine tune expectations. There are things sentiment analysis can and cannot do.

Sentiment analysis (like any single indicator) is not infallible and shouldn’t be used as stand alone indicator. The Profit Radar Report always looks at the combined message of supply/demand, technical analysis, seasonality and sentiment.

Sentiment, however can help gauge the probability of a major top or bottom. To illustrate, the July 24 Sentiment Picture attempted to answer the same question: Are there enough bulls to form a major market top?

It stated that: “Considering that stocks just were near all-time highs, sentiment is quite subdued. The lack of real investor enthusiasm, has continually pointed to new highs, and does so again this month. The question is when a bigger correction will occur.”

The ‘bigger correction’ started shortly thereafter, but stocks are trading near their 2015 highs once again.

The September 24 Sentiment Picture noted extreme bearishness and proposed that: “Sentiment is pointing towards a buying opportunity. In fact, purely based on overall sentiment, stocks should be closing in on a tradable low.”

That tradable low occurred three days later at S&P 1,871.

Are There Enough Bulls for a Major Market Top?

Below is the sentiment chart featured in the October 29, 2015 Sentiment Picture. This chart plots the S&P 500 against six different sentiment gauges (the actual sentiment analysis includes dozens more indicators):

  • CBOE SKEW Index
  • CBOE Equity Put/Call Ratio
  • CBOE VIX
  • National Association of Active Money Managers (NAAIM) equity exposure
  • Percentage of bullish advisors polled by Investors Intelligence (II)
  • Percentage of bullish retail investors polled by the American Association for Individual Investors (AAII)

The second chart highlights investor sentiment surrounding the 2007 high.

  • In 2007, the VIX was trading near 16. This was 50% lower than the August high (near 30), but 60% above the 2007 low (near 10).
  • The CBOE Equity Put/Call Ratio (5-day SMA) was towards the lower end of its range.
  • The SKEW wasn’t extremely high, but towards the upper end of its range.
  • Investment advisors and newsletter writers (polled by Investors Intelligence – II) were extremely bullish.
  • Retail investors (polled by the American Association for Individual Investors – AAII) were extremely bullish.
  • Active investment managers (polled by the National Association of Active Investment Managers – NAAIM) were bullish.

In October 2015, investors are not as bullish as they were in 2007. This becomes particularly obvious when looking at the AAII, II and NAAIM crowd.

Since the October sentiment picture was published, investors have become a bit more bullish. Perhaps even bullish enough for another pullback (there was also some significant internal weakness last week), but investor enthusiasm as not as pronounced as it was in 2007 or other historic market tops.

Investor sentiment is just one of the four powerful price movers monitored by the Profit Radar Report. Here is a (free) detailed look at supply and demand (or liquidity): Is the Stock Market Running out of Willing Buyers?

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.

 

This VIX Trick is Stumbling Investors

On August 24, the VIX briefly soared to 53.29, I was getting ready to leave for Europe that day, but saw the action on my phone and thought: “Boy, wish I had the time to figure out a good VIX short.”

I even wrote in the August 24 Profit Radar Report update that: “Today’s VIX high (53.29) will likely stand for a while. Buying XIV (inverse VIX ETN) is tempting, but the issue with XIV is that we may not have the benefit of contango right now, but the drag of backwardation.”

An explanation of contango and backwardation (along with the best seasonal VIX signal) is available here (last two paragraphs).

In short, backwardation is a condition that either increases XIV or SVXY losses or erodes XIV and SVXY gains while the VIX trades above 20 – 25.

The chart below plots the CBOE VIX against the VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV). Another inverse VIX vehicle is the ProShares Short VIX ETF (NYSEArca: SVXY).

Although the VIX retreated more than 50% since August 24, XIV is up ‘only’ ~10% (SVXY is up ~8%).

Welcome to the power of backwardation.

Understanding contango and backwardation is vital for VIX investors.

Just as backwardation is hurting XIV and SVXY right now, contango will likely benefit them later on this year.

The VIX seasonality chart offers strong clues when the next good setup will be. This is the same VIX seasonality chart that triggered a buy signal in early July.

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.

‘Black Swan Risk Canary’ Soars to All-Time High

Many times catchy headlines do not deliver any content even remotely as interesting as the title. But this catch headline is backed up by one of the most accurate stock market indicators in recent years.

What’s the ‘Black Swan Canary?’ It’s the CBOE SKEW Index.

The SKEW Index is calculated by the CBOE. The CBOE, the same outfit responsible for the CBOE VIX.

According to CBOE, the SKEW Index 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.

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Similar to the CBOE VIX or VIX Volatility Index (NYSEArca: VXX), the price of the S&P 500 (NYSEArca: SPY) tail risk is calculated from the price of 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 highest SKEW reading was recorded on October 16, 1998 and was matched by last Friday’s spike to 146 (the chart below was originally published in Sunday’s Profit Radar Report).

Here are probably the two most salient points about the SKEW/S&P 500 relationship:

  1. The SKEW has established a sequence of higher highs. It has taken progressively higher SKEW readings to get the S&P 500 in trouble (134 in April 2010 was enough to ‘cause’ the ‘Flash Crash’. 143 in December 2014 only led to a minor eventual pullback).
  2. Nevertheless, an elevated SKEW has tripped the S&P 500 (at least to some extent) every time. If this track record continues, Friday’s SKEW spike should cause some choppiness.

Although the 2010 and 2011 corrections were quite nasty, the label ‘Black Swan Index’ has been misleading in recent years.

This time may be different, but the SKEW has been one of the most accurate indicators in an environment that’s fooled many other trusted gauges.

The SKEW suggests a bumpy ride ahead with limited gains and elevated risk.

I always recommend looking at more than one indicator (I personally monitor various indicators from three different categories: Sentiment, seasonality and technicals).

The SKEW’s meaning is nicely enhanced by a simple Dow Jones (NYSEArca: DIA) chart. Right now a rare Dow formation offers clear levels of ruin and opportunity.

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.

Smart Option Traders ‘Smelled’ the Latest Bounce

The Volatility Index (VIX) has not lived up to its contrarian indicator reputation, but there is another CBOE options index that’s provided some noteworthy signals. Say hello to the options indicator of the future – the SKEW.

A pilot literally monitors dozens of controls to navigate the aircraft safely through the air.

Like a pilot, the Profit Radar Report constantly monitors dozens of different stock market gauges.

Once a month, the Profit Radar Report publishes the Sentiment Picture. Radar like, the Sentiment Picture searches for sentiment extremes.

Shown below is the May 2013 Sentiment Picture (published on May 19), which plots the S&P 500 against five different sentiment gauges:

1) CBOE VIX
2) CBOE SKEW
3) CBOE Equity Put/Call Ratio
4) Percentage of bullish advisors polled by Investors Intelligence (II)
5) Percentage of bullish investors polled by the American Association for Individual Investors (AAII)

After many months of average readings, the May Sentiment Picture finally showed some extremes. Most notable were the up tick in the SKEW and the drop in the equity put/call ratio.

Unlike polls, the equity put/call ratio is an actual money flow indicator. It showed that investors are putting their money where their mouth is and indicated that risk for bulls was rising.

The actual sell signal was triggered based on technical analysis on May 28 with a target of 1,594 – 1,598 for the S&P 500.

The sell signal proved correct, but it was in contradiction to a bearish SKEW extreme, which is generally bullish for stocks.

On May 28, the SKEW was about the only indicator that suggested higher stock prices. Although the SKEW is quite accurate (see green and red lines on the second chart) its message was simply overruled by the majority of bearish indicators (but its message was only tucked away, not forgotten).

The SKEW – an options-based index like the VIX – in essence estimates the probability of a large decline. A reading of 135+ suggests a 12% chance of a large decline (two standard deviations). A reading of 115 or less suggests a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

The second chart plots the S&P 500 against the SKEW only.

A week later the lonely SKEW signal received backup by extremely bad breadth. Breadth was so bad, it’s actually good.

The June 6 article iSPYETF article noted a NYSE Advance/Decline Ratio that’s usually seen at market bottoms. Now there were two – the NYSE A/D ratio and the SKEW.

Both gauges have a good track record and on June 6 stocks staged a bullish intraday reversal after nearly touching the 1,598 down side target. It seems like options traders were the first to ‘know’ that a bounce was forthcoming.

A pilot is taught to always trust his instruments, not his instincts or emotions. Investment gauges aren’t as reliable as aircraft instruments, but investors should trust them much more than their own emotions. Does the bounce have legs?

The ‘instruments’ are telling me right now that stocks need to move above resistance (the lower lows, lower highs sequence has yet to be broken) or below support to trigger the next move. This may sound vague, but sometimes the market lacks clarity and when that happens it’s smart to stay on the sidelines.

It’s better to miss a trade than to lose money on a trade. The job of the Profit Radar Report is to spot and profit from high probability trades.