'Black Swans' can't be predicted, otherwise they wouldn't be considered 'Black Swans.'
Nevertheless, the Chicago Board Options Exchange (CBOE) - the same outfit that calculates the VIX - formulates an index designed to measure the risk of a sizeable drop. It's called the SKEW Index.
The SKEW is designed to measure the tail risk of the S&P 500 (^GSPC). What’s tail risk?
Tail risk is the risk of outlier returns two or more standard deviations below the mean. Some call this a ‘Black Swan’ event or simply a sudden drop.
Similar to the VIX, the S&P 500 tail risk is calculated from the price of S&P 500 (SPY) out-of-the-money options.
The SKEW typically ranges from 115 to 135. Readings of 135 suggest a 12% chance of a large decline (2 standard deviations). Readings of 115 suggest a 6% chance of a large decline.
The chart below, featured in the July 6 Profit Radar Report, plots the S&P 500 against the SKEW.
Last week the SKEW spiked to the second-highest reading in history (142). That's not a fluke. The 10-day SKEW SMA is also at an all-time high, a reflection of persistently high readings.
As the red bars illustrate, the SKEW has been a trustworthy indicator of S&P pullbacks since the beginning of the QE bull market.
According to the SKEW, the odds for a swift decline are at a historic max. However, the bearish SKEW should be balanced with the indicator that foresaw a persistent S&P 500 rally without correction months ago (this indicator would still allow for higher S&P prices).
A detailed look at this truly fascination gauge is available here:
Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.
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