Tail Risk Indicator Back To Extreme Levels


2014 may well eventually be known for its buildup of various warning signs in the stock market. While the trigger that brings such warnings to fruition may not occur this year, there is no shortage of concerns piling up. One such warning that we have mentioned several times this year is the CBOE SKEW Index. As a refresher, SKEW is an options-derived measure of market tail risk, i.e., risk of an outlier, black swan event (more SKEW specifics at CBOE). The latest warning shot from the SKEW came yesterday.


SKEW readings above 140 have typically been thought to indicate elevated risk of a black swan event occurring. Yesterday, the SKEW hit 140 for just the 11th time since its inception in 1990. Of those 11, 8 have come in the last 11 months.

So what does this unprecedented string of elevated SKEW readings mean? As it is unprecedented, nobody knows for sure. Perhaps investors are merely taking advantage of cheap prices to put on protection against a calamitous event given the aforementioned laundry list of warnings.

That is conjecture, however. The only thing we can definitively measure is the market action subsequent to previous readings above 140. And if history is any guide, that action provides us with yet one more concern over the coming weeks and months. Here is the S&P 500 performance when trading near a 52-week high when the SKEW registers over 140 (note: using the “near 52-week high” filter removes just 1 occurrence, in October 1998 when the market was just emerging from a significant selloff).


As the table shows, 7 of the 9 instances saw losses from 3 days out to 1 month. Excluding those that are too recent to generate a 3-month return, 5 of the 7 were negative 3 months out, by an average of over -3%.

Now this development doesn’t guarantee losses over the next few months. There certainly may be overriding factors that move this market higher. However, this is yet another sign that this relentless rally is perhaps occurring somewhat in defiance of gravitational forces.


“_ rare visitor _” photo by Ia_imagen.

Read more from Dana Lyons, JLFMI and My401kPro.