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Wednesday, June 24, 2009


downside skew

via bloomberg:

Downside skew, which gauges the relative cost of buying insurance against a slide in stocks, is now higher than it was when the Standard & Poor’s 500 Index dropped to a 12-year low on March 9. That indicates a “relatively high chance of downside moves,” the brokerage wrote in a report dated yesterday. ...

“The sharp move higher in risky assets off the early March lows had pushed hedging to the back burner,” a team of analysts led by New York-based Sivan Mahadevan wrote. “Downside skew has risen recently, implying that the probability of large negative moves is actually somewhat higher.” ...

The difference between the cost of put options to hedge against a 30 percent drop in equities and the cost of options to protect against a 10 percent decline is now at its highest since February, the brokerage said. The spread, which is one way of measuring so-called skew, is now higher than it was when the S&P 500 dropped to its lows in March.

“The fact that skew has ticked up in the recent past suggests to us that derivatives users seem to agree that tail risks are still present,” the analysts wrote.

that probably goes hand-in-hand with this report from fortune:

A key market measure of the health of the biggest global financial institutions has deteriorated this month, after showing sharp improvement in April and May.

The price of betting that big banks will default on their debt -- made via derivatives known as credit default swaps -- has risen 17% in June, according to data from New York-based Credit Derivatives Research.

The uptick in wagers against banks such as Bank of America (BAC, Fortune 500), Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500) comes as the spring's scorching stock market rally peters out and doubts about the health of the global economy and the banking sector re-emerge.

UPDATE: adam warner with more on put skew:

Now again, let's take this as accurate, the highest skew since March. And I would agree that signals demand for OTM puts (I mean that's the definition of why skew would lift).

But let's think about it for a sec. The author and the team of analysts assume the probability of a negative move has increased. Because someone is buying puts? Isn't that actually bullish on a contrarian basis? Why do we assume it's smart money buying and not incorrectly nervous money? Why can't this just be a relatively sensible and innocuous "insurance" buy against a good quarter?

Bottom line as my friend Don Fishback will always remind me is, we just don't know the answer to any of these questions. All we know is put demand increased, which without any other wisp of info is actually bullish.

And as long as we're on the subject, the chart here shows a ratio of the VIX to the VXO. The VIX incorporates every near and/or 2nd nearest month strike in it's calculation until it hits two with no bids. So thus it picks up lots of ATM puts and incorporates skew in it's formula. The VXO just takes a few near money strikes (and is OEX as opposed to VIX, which looks at SPX). Theoretically, this ratio should hit a high when skew is most pronounced. Yet it troughed in March. Which seems to make little sense.

Not sure I have a point there, just a related observation.

adam's contextual observations are as always as informative as his subject matter. i'm going to track this VIX:VXO "skew ratio" chart in my header links.

looking at the skewness on a more granular level -- adam's right to point out that skew peaked early in 2009, in fact ahead of the majority of the big bear move into the march lows. the peak reading came mid-january; the peak of the 20ema came first week february. the rebound uptrend off the november lows had peaked in first week january.

moving back to the fall into the november lows, a similar pattern emerges -- while the reaction off the october low peaked on the first day of november, skew ratio peaked in last week october and 20ema mid-november. this wasn't much of a trading signal.

back again to the great crash of 2008 into october -- the peak skew ratio read came a couple days into may and 20ema first week may, whereas the high in the SPX registered mid-may.

now, this is just another indicator of course and has to be contextualized. but there is also a clear correlation between skew extrema and price extrema, and often there is some divergence around turning points. this is at least worth watching, and i'll add it to my daily screens as well to get some feel for it over coming months.

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