The SKEW: A Lesson in Positioning

The SKEW is a vital tool for any investor, but what is the SKEW?

Simply put the SKEW measures the perceived tail risk of a 2 standard deviation drop from current levels, this is achieved by measuring the value of Out of the Money Options (OTM).

The differences between OTM options vs At the Money options (ATM) or In the Money options (ITM) is not particularly relevant for investors to understand, although it does help, in order to use the SKEW, although i may discuss the topic at a later stage if people are interested.

So how do you use the SKEW?

Firstly, i want to make this clear, the SKEW, and indeed any other 'Internal' metric that investors use are not precise timing indicators.

They will not tell you the precise moment the market will drop or the precise moment the market will rally, but they will assist with highlighting what the positioning of other market participants is, or give a rough idea at least, and that is crucial.

How to read the SKEW:

Below 115: The hedge funds within the market are not concerned with the prospect of a 2 standard deviation drop from current levels. i.e. a market pullback/ crash is unlikely or at least, not being priced in by the hedge funds.

Above 135: The hedge funds within the market are bidding up OTM put options (insurance for if the market drops), in other words, the smart money is beginning to position themselves, because they are becoming wary of the market. 

As you can see from the above chart, the SKEW can signal caution, or even outright alarm for quite sometime before the market corrects, or in the case of late 2018, outright tanks.

The more observant reader will also note that the SKEW is currently at levels that we have not seen, since the crash at the end of 2018, signaling caution for those investors in the know and able to read the signals, which now you are able to be counted among them.

- Trading_Edge