CBOE Skew Charts Signal Significant Market Top

CBOE Skew is an option based indicator that attempts to measure the risk of the S&P 500 in providing an outlier market move, for example, drastic market selloffs that result in drops exceeding two or more stnadard deviations below the mean.  Rather than discuss the math behind the calculation, let's simply reference the charts to study correlations. The orange chart, courtesy of the folks at Bloomberg (annotations added by Keystone), shows the Skew with current reading at a nose-bleed 136, the highest levels since the 2007 broad market top. The 115 level is an average level for Skew. The green circles show significant market bottoms, the red circles show market tops, the April 2010, April 2011 and July 2011 tops were all significant highlighted by the double red circles. The late October 2011 and even the mini January 2012 tops are shown by Skew's at 130-ish.  Note the double red circle on the right margin showing today. What is it telling you?

The Skew versus SPY chart, also courtesy of our friends at Bloomberg (annotations are added), shows the market correlation between the Skew and the S&P 500 (SPY is the ETF for the S&P 500, the 'spiders'). The orange line is the Skew and the green line is the SPY.  The green circles show where market bottoms occurred and the red circles show the late October top, the mid January mini top, and now, a convoluted wild up down up move, testimony to the internal shakiness in play. Like the first chart, this chart shows that something special is occurring now, we simply have not seen the result yet.

The third chart is courtesy of the CBOE (annotations are added), and shows a longer term perspective of the Skew. Note the red circle top in 1990 signaling the beginning of the recession back then, that was short-lived, and the green circle shows the all-clear signal for bulls from 1991 on.  The market top in the late 1990's is easily seen with the highest Skew number.  The 2006-2007 area was identifying a significant maket top as well. Note the Fall 2008 crash highlighted by the catapulting VIX at 80 (which signals a market rally), and the Skew was bottoming in this area in early 2009, where the market bottom was identified when QE1 was announced in March 2009.

Thus, if we fast forward, Skew is well into the 130's now, which is bear-favorable, not bull favorable. The big question, as always, is when? The lesson is stay on guard, the markets are not to be approached in a cavalier, complacent mindset as nearly all traders are viewing the markets currently, a contrarian approach appears to be a wiser path forward, at the least, apply protection if the portfolio is exposed largely on the long side. This information is for educational and entertainment purposes only. Do not invest based on anything you read here. Consult your financial adviosr before making any investment decision.

http://www.bloomberg.com/quote/SKEW:IND/chart

http://www.cboe.com/micro/skew/documents/SKEWFAQ.pdf