Anything For You All: One jarring statistic shows traders are the most scared in 28 years of a sudden market meltdown

One jarring statistic shows traders are the most scared in 28 years of a sudden market meltdown

A stock-market measure that reflects investor worry around a low-probability meltdown is at its highest level on record, according to data going back to 1990.
It may not be immediately clear what could cause such a catastrophic event, but investors are playing it safe nonetheless.

Things are quiet in markets right now. Perhaps too quiet.

That's the thought process being employed by traders who are paying the most in at least 28 years to protect against a significant market event.

Their trepidation can be seen in the Cboe SKEW Index, which is sitting near its highest level on record, according to data going back to 1990.

Developed in the aftermath of the 1987 stock-market meltdown, the SKEW index reflects the degree to which traders are paying a premium for out-of-the-money put contracts, relative to their call counterparts.

In other words, it serves as a handy gauge of hedging activity around so-called tail risk — which Cboe defines as a sell-off exceeding two standard deviations.

Cboe notes that its SKEW index has historically stayed between 100 and 150. But the measure ended last week above that upper boundary — and also spent time above the threshold a month ago, Bloomberg notes. For context, the gauge's historical average is 119.

So what does it all mean?

The simplest explanation is that traders see the conditions building for a sudden negative market event — especially since US indexes are sitting close to all-time highs, meaning they'll have further to fall if conditions go south quickly.

With many traditional valuation metrics suggesting the market is priced for perfection, a lot could go wrong as trade-war headlines swirl and parts of the high-flying tech industry appear poised for a growth slowdown. The traders responsible for pushing the SKEW index up so high are trying to make sure they're not caught flat-footed.

Looking beyond the practice of hedging, it's also possible that investors are skeptical the US market has much further to climb.

That type of thinking could be keeping them from buying as many bullish out-of-the-money call contracts. That would, in turn, push the SKEW index higher, because calls are the denominator in the equation.

Before you dismiss the possibility of a sharp market decline, consider that some experts have been expecting one for months.

John Hussman — a former economics professor who's now the president of the Hussman Investment Trust — says stocks are going to drop more than 60%. At the same time, Leuthold Group has repeatedly drawn parallels between today's market conditions and the early-2000s tech bubble.

In the end, the higher the SKEW index climbs, the more prepared the market will be for any sort of tail-risk event. And it's ultimately an encouraging sign the measure is so high at a time when stocks are so stretched. Read »

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