Traders work on the floor at the New York Stock Exchange, December 9, 2019.
Brendan McDermid | Reuters
Many Wall Street indicators show that investors are confident about the future of the market, but some traders are bracing for the worst.
The Cboe Volatility Index, commonly known as the VIX, is trading near its lowest level this year, and a Bank of America-Merrill Lynch indicator shows market stress well below normal.
The VIX, often called Wall Street’s “fear gauge,” measures implied near-term volatility expectations in the S&P 500 via prices for options on the benchmark. After a small spike last week, the index has fallen more than 20%. It currently trades at just above 12, well off its 52-week high of 36.07. The higher it goes, the more fearful traders are and vice versa.
“Many of the reasons for dampened near-term volatility rest with the behavior of the Fed and other developed market central banks globally,” William Blair said in a note to investors last week. Rate cuts have the effect of pushing more liquidity into the markets and aiding the economy.
However, the Cboe SKEW Index, which represents how traders are pricing the possibility of a “black swan” event, is trading near its highest level for the year. The SKEW Index is based on pricing for S&P 500 options that are well “out of the money” and would only come into play if the market moves significantly. Both the VIX and the SKEW look at volatility at a 30-day horizon.
The SKEW reached its highest level of the year on Friday, according to data from Cboe. The SKEW to VIX ratio is above the 95th percentile of its historical range, according to Roberto Friedlander, the head of energy trading at Seaport Global Securities.
“SKEW index tends to be traded more by the quote-unquote professional-type traders, so they’re certainly paying up for premium for a black swan-type event … obviously we’re going through impeachment process now or some sort of trade event or a geopolitical event,” Friedlander said.
The preparation for serious volatility mirrors recent trends in the long-term option markets, where traders are hedging against the possibility of a market pullback next year after the United States presidential election.
The S&P 500 is having one of its best years since the turn of the century, up more than 25% year-to-date.