By Joseph Adinolfi
So-called realized volatility skew has fallen to its most negative level in more than 20 years, according to Cboe.
There is an old saying on Wall Street: stocks take the escalator up and the elevator down.
It is rooted in the notion that while selloffs are often swift and intense, bull markets typically take more time to play out.
But over the past few years, investors have flipped this tendency on its head, according to an analysis by Mandy Xu, head of derivatives market intelligence at Cboe Global Markets.
Since 2022, the stock market’s daily moves to the upside have generally been more violent than down days.
And since the beginning of 2024, the margin of upside volatility compared with downside volatility, which derivatives-market experts refer to as “realized skew,” has shifted toward its most negative level in 22 years. The last time realized skew was lower was in 2002.
That year, the S&P 500 SPX fell 23.4% as markets bottomed out following the collapse of the dot-com bubble, according to FactSet data. Although skew remained negative in 2003, when the market rose 26.4%.
“Markets have been taking the escalator down and the elevator up – so to speak – reversing the traditional behavior. This has gotten even more extreme so far in 2024,” Xu said in her report.
Xu’s report was published ahead of Tuesday’s selloff. But she confirmed in an email to MarketWatch that while realized skew has improved slightly since the S&P 500’s latest 1% daily drop, it remains firmly negative at -2.3, still on track for the lowest calendar-year reading since 2002, when skew fell to -4.
So-called realized volatility skew is, according to Xu, a statistical measure which compares the standard deviation of moves on up days to moves on down days. The spread is measured in so-called volatility points, similar to the Cboe Volatility Index, better known by its symbol, VIX VIX.
But while the VIX measures how volatile investors expect markets to be over the coming month based on activity in S&P 500 options, realized volatility measures how volatile markets actually have been.
What does this tell us about markets? According to Xu, it could help explain why options traders have recently favored bullish call options over bearish puts.
As she pointed out in a report published last month, demand for out-of-the-money put options compared with out-of-the money call options – known as implied skew – touched its lowest level in a decade following Nvidia Corp.’s (NVDA) blockbuster earnings report.
Other derivatives-market experts, including Nomura’s Charlie McElligott, have characterized this dynamic as a manifestation of investors’ “fear of missing out” on further gains in a market that has seen the S&P 500 rally by more than 21% during the four months through February. By one measure, the rally over the past four months has been the most consistent since 1971.
See: S&P 500 scores gains last seen in 1971 as AI hopes fuel ‘second’ leg of rally
McElligott has characterized options market activity as investors bracing for a “crash up” while continuing to discount the likelihood of a crash. Xu’s research suggests that options traders are simply reacting to what has taken place in markets over the past few years.
After all, implied volatility remained relatively subdued in 2022 as the market steadily drifted lower over nine months, the rare selloff that took place without a market crash that sent the VIX soaring.
U.S. stocks traded higher on Thursday as the main indexes looked to claw back tech-driven losses from earlier in the week. The S&P 500 was up 0.8% at 5,144 in recent trade, having erased its losses from earlier in the week to trade just shy of a fresh intraday high.
The Nasdaq Composite COMP gained 1% to 16,185. The Dow Jones Industrial Average DJIA was up 150 points, or 0.4%, at 38,809.
-Joseph Adinolfi
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03-07-24 1031ET
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