Earlier in the week we highlighted a number of charts that indicate VIX (or short-dated vol) is under-pricing risk. The cheapness of vol has continued – especially now that Goldman has started to promote the buy-write strategy (offloading their positions?) that we felt was largely responsible for the rise in implied correlation (more macro demand for protection than micro). Today we look at what appears to be another leading indicator of stress ahead in short-term vol.
The skew (or difference between an at-the-money option and an out-of-the-money option) ‘measures’ the market’s comfort with normal risk (small moves) relative to more extreme moves – the higher the skew, the more concerned a market is at hedging extreme moves. Over the last few years, when the skew has spiked, VIX has been very close behind reflecting an underlying and consistent concern of tail risk juxtaposed with momentum chasing vol-premium gatherers in the short-term at-the-money options. Current levels of skew are the highest since early 2011 and as the chart infers, suggest VIX is due for a correction significantly higher.
* highlighted text from Zero Hedge