SKEW Index

What Is the SKEW Index?

The SKEW index is a measure of likely risk in financial markets. Similar as the VIX index, the SKEW index can be a proxy for investor sentiment and volatility. The Skew Index measures perceived tail-risk in the S&P 500. Tail-risk is a change in the price of the S&P 500 or a stock that would place it on both of the tail closes, or the furthest edges of the normal distribution curve. These price changes commonly have a low likelihood.

Understanding the SKEW Index

The SKEW index is calculated utilizing S&P 500 options that measure tail risk — returns at least two standard deviations from the mean — in S&P 500 returns over the course of the next 30 days. The primary difference between the VIX and the SKEW is that the VIX depends on implied volatility round the at-the-money (ATM) strike price while the SKEW considers implied volatility of out-of-the-money (OTM) strikes.

SKEW values generally range from 100 to 150 where the higher the rating, the higher the perceived tail risk and chance of a black swan event. A SKEW rating of 100 means the perceived distribution of S&P 500 returns is normal and, in this way, the likelihood of an exception return is small.

In particular, the index measures the slant of implied volatility, which can then be communicated as the likelihood of a two or even three standard deviation move by the S&P 500 over the course of the next thirty days. Skew can accordingly be utilized to assist with deciding risk.

To comprehend how the SKEW Index mean risk, consider that every five-point move in the SKEW Index adds or deducts around 1.3 or 1.4 percentage points to the risk of a two-standard deviation move. Essentially, a five-point move in the index adds or deducts roughly 0.3 percentage points to a three-standard deviation move.

The index increments general market awareness among investors. As the incline of implied volatility moves higher, it raises the SKEW Index, which demonstrates that a Black Swan event is turning out to be more probable yet not that it will really happen.

In practice the SKEW index has been a poor indicator of stock market volatility. Financial author Charlie Bilello noticed data from the greatest one-day falls in the S&P 500 and the SKEW Index going before these falls. "Returning to 1990, none of the most terrible declines had a SKEW Index in the prior month that was inside the top 5% of historical values. Thus, when genuine tail risk was available, SKEW didn't anticipate it," Bilello said.