VIX Skew - What it Indicates and How Accurate it is

VIX is 31.73 with IV30™ (vol of the vol) down 7.6% today in part on Bernanke's calming remarks about Europe. The LIVEVOL™ Pro Summary is below.



Just to be clear, we are forward indexing, or in English, we are using the options to estimate where the futures are. We are not using the spot VIX.

To aid in the analysis of VIX skew I will refer back to the 6 month VIX chart several times. The Charts Tab (6 months) is below (click to enlarge). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue). The yellow shaded area at the very bottom is the IV30™ vs. the HV20™ vol difference.

I will focus on the top part - where I have highlighted a bunch of intervals.



Let's start with how the VIX skew looks today (click to enlarge).



Of course, in isolation this means nothing, so let's juxtapose this chart with the VIX skew from 5-11-2010 (right before the VIX explosion). See the VIX chart above - I have highlighted the area starting on 5-11-2010 and moving through that spike.



We can see the skew today is much flatter on the upside than it was prior to the May spike. We can see from the VIX chart above that from ~5-26-2010 through today the VIX has been relatively stable. You can in fact see the dip in the HV20™ (the blue line on the bottom portion of the VIX chart) over the last two weeks. The skew chart on 5-26-2010 looks very similar to the one today (click to enlarge) i.e. flat.



Note the upside is flattish(ish) relative to the 5-11-2010 skew. To recap thus far, the flattish skew as of 5-26-2010 was a good indicator that the near term risk was low. The steep 5-11-2010 skew was a good indicator that risk was high.

Let's go a bit further. We see on the VIX chart above that 4-21-2010 and 1-19-2010 were right before VIX spikes. The skew charts for those two days are included (click either to enlarge).





We can see these two skew charts were right on the money. That is, the upside bend indicated higher risk and in fact the VIX rose hard right after for both.

So far it looks like the VIX skew is the great golden bullet. It's perfect right? Well, no... From the VIX chart at the top we see from 4-21-2010 through mid May that the VIX was just ripping. And yes, the skew indicated that on 4-21 and 5-11. But, right in the middle, on 4-30-2010, as the VIX was poised to make it's largest jump, the skew changed to a flatter shape. The skew chart for 4-30-2010 is included (click to enlarge).



And of course, that flat skews was not correct.

Conclusion
VIX skew can be a good indicator of the future. It can also fail in that regard. In actuality the VIX skew is just the sum of expectations for the future. And expectations of the market can be right or wrong.

Right now: The VIX skew reads "calm." Is it right this time, or wrong? What do you think?

This is trade analysis, not a recommendation.

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