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Is Skew Signalling a Pullback?

There is one fact that I can easily state: there is not a single indicator that works all of the time.  Despite that, there are some indicators that I tend to like.  The CSFB “Fear Barometer” is one of them.  As a rehash of what this indicator measures:

The Fear Barometer is a way to measure skew in a consistent format through the pricing of a “zero-cost collar”. The index assumes that you sell a 3-month, 10% out of the money call and use the proceeds to purchase a 3-month out of the money put. The moneyness of the put option that you can afford is the index itself, so if the index is at 25 it implies that you can purchase a 3-month put 25% out of the money with the premium that you received from selling the 10% OTM 3 month call.

In that same post on April 4, 2011 I made the following statement:

Of course there is no one perfect predictor of market tops and bottoms, but I will say that this peak stands out and should be noted. It certainly does not give me a comfortable backdrop for being overly bullish.

I will gladly make the same statement today with the CSFB index level currently sitting at 32.11 (close to all time high):

The record level in the 30's is an interesting dynamic in the options markets

If you want to rationalize why the skew is so high you could make the following statements about option market sentiment:

  1. Low demand from call buyers (bearish)
  2. High supply of call sellers (bearish)
  3. High demand of put/protection buyers (bearish)

I am not sure that the supply of put sellers is ever a true driver of skew so I will leave that out of the mix.

The S&P 500 is less than 35 points away from its all time price index high so it seems to be a foregone conclusions that those highs will be touched.  The question is whether 2013 is shaping up to have a May-October risk-off pattern that we have seen in the last few years:

Sell in May…or maybe April?

It seemed like 2012 was a rather kind year from the markets.  It might be that a bit more turbulence is brewing for 2013.

Posted in Markets, Technical Analysis, Trading Ideas.

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