What Is the SKEW Index and How Does It Measure Market Risk?

Investors and traders seek ways to gauge market risk, particularly the likelihood of extreme events. While the VIX measures expected volatility, the SKEW Index offers a different perspective by assessing the probability of significant market moves that deviate from normal expectations.

Understanding what influences this index and how it compares to other risk indicators helps investors make informed decisions.

Key Components of the SKEW Calculation

The SKEW Index is derived from S&P 500 options pricing, focusing on the implied volatility of out-of-the-money (OTM) put options relative to at-the-money (ATM) options. Investors often buy OTM puts as protection against market downturns, increasing demand and driving up their implied volatility. This difference in volatility reflects the perceived probability of extreme downside moves.

The Chicago Board Options Exchange (Cboe) calculates SKEW by analyzing a range of OTM put options with varying strike prices. The further out-of-the-money an option is, the more its price is influenced by expectations of tail risk. By aggregating these implied volatilities and comparing them to ATM options, SKEW quantifies the degree of skewness in the options market. A higher SKEW value suggests traders see a greater probability of large market declines, while a lower value indicates a more balanced distribution of expected returns.

Factors That Can Affect SKEW Readings

Investor sentiment plays a major role in shaping SKEW values, especially during periods of heightened uncertainty. When traders fear downturns, demand for deep OTM put options rises, pushing up their implied volatility and elevating SKEW. Events such as geopolitical tensions, unexpected economic data, or shifts in Federal Reserve policy can trigger these reactions.

Liquidity conditions also influence SKEW. When liquidity is abundant, market makers efficiently price options, keeping volatility spreads stable. In low-liquidity periods—such as around major holidays or after financial crises—pricing inefficiencies can cause SKEW to spike or drop sharply even if broader market conditions remain unchanged. Institutional trading strategies, such as structured product hedging or volatility arbitrage, can also distort the index when large-scale option trades impact implied volatility.

Structural factors within the options market contribute to fluctuations as well. Changes in margin requirements or adjustments to risk models by financial institutions can alter positioning in derivatives markets. If brokerage firms impose stricter margin rules, traders may be forced to unwind positions, affecting option pricing. Regulatory shifts, such as modifications to capital requirements, can also impact how institutions manage risk, indirectly influencing SKEW levels.

Comparing SKEW to Other Market Volatility Gauges

Market participants rely on multiple indicators to assess risk. While SKEW provides insight into the probability of extreme downturns, it differs from other volatility measures. Historical volatility, for example, analyzes past price movements but does not account for future expectations. SKEW, by contrast, reflects the market’s forward-looking assessment of tail risk, making it useful for identifying periods where traders anticipate significant but unlikely price swings.

Realized volatility, which tracks actual price changes, can confirm whether markets have experienced the turbulence that implied metrics like SKEW had previously signaled. A divergence between high SKEW values and low realized volatility suggests traders may be overpricing downside risk due to external fears that have yet to materialize. Conversely, if realized volatility rises sharply while SKEW remains subdued, it indicates the market was unprepared for the observed fluctuations.

Unlike broad market volatility indices that incorporate both upside and downside expectations, SKEW focuses specifically on asymmetry in risk perception. Some volatility indices provide a more balanced view of expected movement, while SKEW isolates skewness in option pricing. This explains why SKEW may rise even when other volatility indices remain stable—investors could be adjusting their risk protection strategies without expecting an overall increase in market turbulence.

Interpreting SKEW for Potential Market Insights

SKEW can reveal underlying market dynamics that traditional volatility measures may not capture. A consistently elevated SKEW suggests investors are pricing in the possibility of rare but severe downturns, even when broad market indices remain stable. This can reflect concerns about systemic risks such as excessive leverage in financial markets or vulnerabilities in corporate debt. When SKEW trends upward while equities continue to rise, it may indicate that institutional investors are hedging against a potential reversal despite retail optimism.

Shifts in SKEW can also highlight changing correlations between asset classes. A sharp increase in SKEW may coincide with rising credit spreads or currency market weakness, signaling broader concerns about liquidity or macroeconomic stability. During periods of monetary policy uncertainty, a divergence between SKEW and bond market volatility can provide clues about whether investors expect financial conditions to tighten abruptly. Similarly, if SKEW spikes while equity implied volatility remains subdued, it suggests traders anticipate tail risks that are not yet reflected in near-term market pricing.

Practical Uses in Options Positioning

Traders and institutional investors use SKEW readings to refine risk management and optimize portfolio hedging. Since the index reflects the relative cost of tail-risk protection, it helps determine whether downside hedges are overpriced or underpriced. When SKEW is elevated, deep OTM put options tend to carry a higher premium, making traditional protective strategies more expensive. In such cases, traders may explore alternatives like ratio put spreads or put butterflies to reduce costs while maintaining downside protection. When SKEW is low, long put positions may offer more attractive pricing, allowing investors to secure hedges at a discount relative to historical norms.

Market makers and volatility arbitrageurs also use SKEW to identify mispricings in the options market. A steep skew curve may indicate that put options are trading at a premium, creating opportunities for selling volatility through structured trades. For example, traders might sell expensive OTM puts while purchasing closer-to-the-money puts to construct a credit spread, allowing them to capitalize on inflated risk premiums while limiting downside exposure. Funds specializing in tail-risk hedging may adjust their positioning based on SKEW fluctuations, either increasing or reducing exposure to extreme downside scenarios depending on how the market is pricing such risks.