The ‘crash protection’ index is sending a warning flare for the market — or not

The chart of an obscure index is making its way around Wall Street. And some say that its recent surge suggests that traders are now more interested in protecting their portfolios from serious downside.

That would be the CBOE skew index, which is near all-time highs. As the CBOE puts it, the index "measures the perceived tail risk of S&P 500 log returns at a 30-day horizon." In other words, it represents an attempt to use options prices in order to determine the market-implied probability of a crash.

"We're at very significant levels" on the index, strategist Larry McDonald said Monday on CNBC's "Trading Nation." In a blog post, he wrote that the main reason for the index's high level is that "[t]oo many market participants don't trust the rally, [so] want to buy [longshot] downside protection."

Some have gone even further, suggesting that the chart shows investors are becoming more nervous about crashes, and that people are paying more to protect themselves against a "black swan" event that could be just over the horizon.

Yet this thrilling story becomes a bit more prosaic once the skew index is brought under the microscope.

The CBOE volatility index (or VIX) is rising on Tuesday, but has remained at notably low levels all year. This indicates that options traders remain confident that the S&P will not move too much.

Meanwhile, since it only measures the relative prices of options, the CBOE skew index "has a big bias to when absolute levels of implied volatility are uncommonly low," Jake Weinig, founding partner of options-focused hedge fund Malachite Capital, said Monday on CNBC's "Trading Nation."

In fact, far from crash protection becoming more expensive, "tail puts are actually near their cheapest levels in history," Pravit Chintawongvanich of Macro Risk Advisors wrote in a derivatives strategy note Tuesday.

The skew index is accurately showing that these long-shot puts have become more expensive relative to ordinary puts and calls, but "that is missing the forest for the trees," Chintawongvanich added.

Since it actually measures something exceptionally narrow, "I don't read into this index too much," Weinig said. The index "certainly is meant to drive fear, but [its high level] can probably be explained by banks buying protection to protect against balance-sheet costs, or different type of relief like that," he added.

That is to say, the skew index may merely be picking up the fact that certain parties retain a willingness to buy crash-protection options — no matter how unlikely it may be that they ever pay off.


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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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