Tags: skew | ratio | stocks | options

Skew Ratio Could Signal Danger for Stocks

Friday, 01 Nov 2013 08:29 AM

By Dan Weil

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While the Standard & Poor's 500 Index and the Dow Jones Industrial Index both closed at record highs Tuesday, an obscure options index could point to trouble ahead for stocks.

Heavy demand for call options on the SPDR S&P 500 exchange-traded fund (ETF) pushed the "skew" ratio to its fifth-lowest level of 2013 last week, according to The Wall Street Journal.

The ratio consists of bearish options prices divided by bullish ones. So a lower skew ratio means prices are rising for calls. Some investors say the current level shows stock market bullishness is overdone, The Journal reports.

Editor’s Note:
5 Reasons Stocks Will Collapse . . .

The recent decline in the skew ratio puts it near a reading that has been followed by stock-market drops of at least 4 percent twice this year, options experts tell the paper.

The skew on the SPDR S&P 500 hit a trough of 1.21 last week, according to Trade Alert. That's down from a three-year average of 1.43, though the ratio recovered to 1.27 Tuesday.

The readings that preceded stock declines earlier this year were 1.16 and 1.19, The Journal notes.

The options activity now may produce a counter reaction. "Sometimes people get a little overzealous, and something happens to bring it back to reality," Frederic Ruffy, senior options strategist at Whatstrading.com, tells The Journal.

Nobel laureate economist Robert Shilling notes that price-earnings ratios, based on 10 years of earnings, are far above average. But that doesn't necessarily portend doom, he tells MarketWatch in an interview at The Economist magazine's Buttonwood Gathering.

"The market is high, but it’s not alarming yet and could go much higher," Shiller said.

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

Related Stories:

Pimco's Bill Gross: The Stock Market and Asset Prices Are 'Bubbly'

JPMorgan's Lee Is Bullish on Stocks

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