SMILE indicator – Volatility Skew Index is smirking

by i-kno-nothing

I’ve dome sone DD on an indicator very few know about called the Volatility Skew. or simply SMILE index.

This is an indicator that measures the IV on ITM & OTM options of different strikes for the same expiration date one week out or so.

When option premiums get “skewed” out of balance, i.e. far OTM option premiums get expensive, it creates a skew when IV is charted based on strike as seen in diagram below:

www.investopedia.com/terms/v/volatilitysmile.asp

in Normal market conditions where large movements are not expected the far OTM option IV and premiums are really low, as these options would normally expire worthless and give little risk to option sellers.

However when the opposite happens, the diagram smiles. indicative of expected large moves.

Currently, the index is teasing ATH levels we saw back in December, way before the market crash in MArch, as seen below:

Skew index on TOS

Now, this value could be tricky, as it is a little less reliable after a major market correction. and people already have the fear of another correction, not to mention we’ve crossed and closed the Feb ATH on S&P. A lot of people maybe expecting a correction hence creating the smirk.

Below is another chart showing the 8/28 IV skew on S&P.

Smirk!

as you can see, the IV is smirking, and it’s a rather steep smirk leaning towards the lower strike puts.

in my believe this means the overall market sentiment is expecting a market correction (please note: with the Fed holding the hefty safety net, worst case scenario is 10%)

I want to point out, fellow autists, this is for educational purposes only. and Market direction is impossible to predict, best you could do is use all the info you have and asses real world conditions to make a judgement. Life events and news announcements ultimately control what the market is going to do. all of these charts and analysis simply shows what is currently anticipated in the market and what the general sentiment is, it is after all like shooting a dart when eyes 99% blindfolded.

Please don’t take this as a “sign” that a market correction is going to happen. best you could do is hedge your positions and reduce your risk tolerance, trim excess profit (if any xD).

All major ETFs are still above trend line, and they haven’t triggered a sell signal. and with Tonald Drump announcing some mysterious “therapeutic” strategically timed this Sunday 6PM he might already know all the above and looking to add some positive push to get over this ATH hurdle.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.