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Could The CBOE SKEW Index Be Projecting A Major Change Of Trend?

The SKEW index has been a popular subject of the alternative media over the past few days. I saw it first in a video by Gregory Mannarino over the weekend. It's pundits would say it could be forecasting a major event.

As a trend follower, I would love it to forecast a major change in market trend quite frankly. It has been a tough ride up on the Fed's money for trend followers and I believe the ride down will be much more profitable for us.

So what is the SKEW Index?

For starters, the CBOE SKEW Index ("SKEW") is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the "skew".

You can see the recent CBOE graphs of the SKEW Index and CBOE Volatility Index (VIX) below:

The thing that instantly stands out to me is (1) that extremes above 140 on the SKEW do seem to correlate roughly with market tops in 2000, 2007-2008 and quite possibly 2014; and (2) the VIX is near 10 in the above graph and was last at this level in 2007, the last major bear market.

Here is a close up of recent trading in the SKEW Index.

As a trend follower, this index is interesting! It brings hope that maybe we are ready for a major trend change, which would be good for us.

However, the first rule of trend following is that we do not predict markets, our models react instead. This is what allows trend followers to capture higher unexpected returns in both directions in a strong trending market. That is because the trend usually goes further than anyone would have expected. In this case, this bull market has gone much farther than I would have expected.

So the obvious question is what do our models say?

The simple answer is most intermediate term models are still stuck in "bull or buy" mode. Some shorter term models are now bearish, but this market has much to prove before I could possibly call this a top.

For you at home, the simple way for you to know what to do is consider a Free 30 Trial to Stock-Signal.com. We will give you the buy and sell signals on 7 major indexes including the broad S&P 500. Many subscribers use this one signal (i.e., the S&P 500 buy and sell signals) to time whether their portfolio should be in or out of the markets since its signals do not occur very often.

You can see the past buy and sell signals, below, since 2007:

Alternatively, if you have access to charting software, you could watch for a break of the rising wedge pattern (dotted blue lines of middle price chart) by the S&P 500 on a monthly chart and that might give you a pretty good signal as well on when to get out. Your only problem is eventually you will need a good signal on when to get back in. This chart does not give you that information.

So the bottom line is the SKEW Index may be telling us something or it may not. You noticed we hit highs above 140 on several recent occasions and just realized one day market sell offs.

So it is way too early to call a top and trying to predict the future is certainly a fool's game!