SKEW is a measure of options prices in the S&P500 Index that divides the options volatilities of puts/calls.
How to use the SSKEW Index gets a bit more cloudy since it isn't always clear or perfect in its "signal generation". But I think it is important to know what it is showing so you can at least decide what the general sentiment and positioning is in the options market for the S&P500 or SPY.
So let's talk about a couple of scenarios:
1. Rising SSKEW and Rising SPY prices. The thinking process behind this combination is that people are selling calls and using the proceeds to buy puts to protect against a market drop. This is a market that is "hedging" as the market goes up. So if people are hedging their longs, they are effectively showing that they are worried about falling prices and that implies the market is "climbing a wall of worry." Markets usually continue to climb in that condition. I have labeled this setup in late May which preceded the advance in stock prices in June.
2. Falling SSKEW and Falling SPY prices. The logic behind this setup is that people are buying calls as stock prices fall, getting more emboldened with price declines, which is a very bearish setup implying lower prices ahead. This is the scenario we had going into the end of July which preceded the drop in August.
You can see that SSKEW has returned to the middle of the range here, so there is no new signal to work from here.
Stay tuned for one of these scenarios to set up again. The next variable to use is the level of VIX to alert us to whether there is active buying of options or selling of options to give us deeper insights into what is likely to happen.
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