There has been some talk recently about the VIX options skew and how it indicates a possible severe market downturn. The rationale is how the skew looks today relative to early September 2009 (before that market collapse). The Skew for today (2-12-2010) and 9-9-08 are included - click either image to enlarge. Note the level of the VIX highlighted in yellow and the dates on the charts.
The Charts Tab snapshot of the VIX (2 years) is included (click to enlarge). Not that we needed a reminder, but the VIX exploded above 80 after that 9-9-08 skew.
So the talk recently (from some) has been that the similar skew today represents a risk of similar explosion in the VIX (an implosion in the market). Fair enough. But how about a different angle?
I have included the Skew chart of the VIX from 7-7-2009 (click to enlarge). Note the similar (granted, not identical) shape to 9-9-2008.
The Charts Tab snapshot for that time shows of course that the VIX traded in a tight horizontal range after that skew - certainly no explosion. The chart is included (click to enlarge).
So, a skew as we see today isn't necessarily a guarantee of the future (good or bad). For completeness I have provided the skew charts from 10-27-09 (right at the height of insanity) and from 3-5-2009 (the market bottom). Note how much flatter the front month is relative to the prior snapshots.
Conclusion? The market is pricing in risk of a downturn - but that's no guarantee it will happen.
Per reader requests I have added the Vol chart with IV30™ (red) and HV20™ (blue) (the bottom section of the chart is vol). The yellow below that tracks the spread between the two. I chose HV20™ b/c it is measured in trading days, where IV is measured in calendar days (weird options market convention since forever) so IV30™ is ~ 22 trading days and tracks closer with HV20™ than HV30™. Click to enlarge.
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