'Black Swan' index flashes yellow: Wall Street is not scared

NEW YORK (Reuters) - The options-based Black Swan index may be signaling surging demand from investors for protection against a stock market crash, but Wall Street analysts see little reason to panic.

FILE PHOTO: Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., December 9, 2019. REUTERS/Brendan McDermid

The Cboe Skew Index .SKEWX is near a 14-month high. It tracks the implied volatility of deep out-of-the-money options - that is, contracts that need a large move in the market before they come into play - on the S&P 500 .SPX.

On Monday, the Skew Index hit 136.56, its highest since October 2018. It last traded at 134.37.

The gauge is also known as the Black Swan index, a reference to the book “Black Swan” by former options trader Nassim Nicholas Taleb that looks at the potentially catastrophic effects of unpredictable events.

The index has at least once preceded a market sell-off. In September 2014, its peak reading came before a 7% drop in the S&P index. However, investors are skeptical about the index’s usefulness as a tool that predicts a market crash.

“Yes, options markets are twitchily expecting the next big crack in U.S. stocks,” Nicholas Colas, co-founder of DataTrek, wrote in a note on Wednesday. “But they have been doing that since 2014, and the S&P has almost doubled during that time.”

Over the last six years, a period marked by exceptionally low volatility in U.S. equities, the Skew Index’s average reading was just shy of 130, 10 points higher than its average over the decade before that.

Analysts said the index has limited significance on its own.

“We monitor 60-something volatility strategies for various hedge funds, individuals, various emerging managers, and there is not one of those strategies that uses it as an indicator,” Stuart Barton, managing partner at New York-based investment adviser Invest in Vol LLC, said.

For trading signals, investors tend to focus on contracts that are closer to where the market is trading, Barton said.

Analysts may shrug off the elevated level of the Skew Index, but that isn’t to say there is no fear on Wall Street.

Potentially market-moving events on the horizon have prompted investors to seek downside protection, said Michael Purves, chief executive of Tallbacken Capital Advisors in New York.

Uncertainties linked to central bank policy, the UK general election and the U.S.-China trade war have boosted demand for protection.

“I would interpret it as a healthy market that’s buying some protection with the market up 25% year to date,” Purves said of the climb in the Skew Index. “Vol’s cheap, and there’s a lot of catalysts.”

Reporting by Saqib Iqbal Ahmed and April Joyner; Editing by Megan Davies and Cynthia Osterman