The Market Has Never Been More Fearful Of An Extreme Event

"There's something going on in derivatives land," is the warning from ADM's Andy Ash and as Paul Mylchreest notes the relationship between VIX and SKEW suggests the options market is pricing in the possibility of a major market event. The process enables professionals to maintain the illusion of calmness in VIX while hedging their positions (as they attempt to unwind as we have shown). Whether this 'event' is a crash or melt-up is historically unclear but given the taper and the trend of the last few years, we suspect the former more likely that the latter.

Via ADM Investor Services' Paul Mylchreest,

A rather thought-provoking chart which we've been looking at is the ratio of the SKEW (the chance of an extreme or outlier event, i.e. OTM versus ATM options) versus the VIX (the expectations for more 'normal' day-to-day volatility - the price of hedging implied by ATM options)... and is an indicator of how the market is pricing the possibility of a potential black swan event.

You can see how extended we are right now… (actually at record highs)

We can’t help wondering when Bill Gross tells the world that he is selling volatility, whether he is, in fact, selling ATM vol and buying OTM vol ???

While (curiously) 2000 didn’t register, the two previous highs in the SKEW/VIX ratio were 1994 and 2007 which turned out to be pivotal dates in terms of changes in market direction.

One up and one down... Which does it look like this time?

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Think briefly about who is buying and who is selling? Thiunk about who is buying deep OTM protection? Smells like the professionals are a little less sanguine than their chatter suggests...

Institutional clients are dumping equities off to retail clients... thank you very much...

and those that can't dump their assets are hedging aggressively (while maintaining the illusion with VIX that all is well)