Saturday, October 30, 2010


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The CSFB is an indicator specifically designed to measure investor sentiment, and the number represented by the index prices zero-premium collars that expire in three months.

The collar is implemented by the selling of a three-month, 10 percent out-of-the-money SPX call option and using the proceeds to buy a three-month out-of-the-money SPX put option. The premium on both sides will be equal, resulting in a term commonly known as a zero cost collar.

The CSFB level represents how far out-of-the-money that SPX put option is, or in insurance terms it represents the deductible one would have to pay before the put kicks in.

So, for example, if the CSFB is at 20, then that means an investor would have to go 20% out of the money to be able to buy a put with the proceeds from selling a call that's only 10% out of the money. That means there is more demand for put protection - a sign of fear in the marketplace.

The index would rise when there is excess investor demand for portfolio insurance or lack of demand for call options.

It differs from the Chicago Board Options Exchange Volatility Index or VIX,. The VIX, calculated from S&P 500 option prices, measures the market's expectation of future volatility over the next 30-day period and often moves inversely to the S&P benchmark.

The VIX is a fear gauge by interpretation, not by definition. It was designed to quantify the expectations for market volatility -- a property that is associated with, but not always correlated to fear.


The Fear Barometer doesn't work as most of us expect it to. It doesn't necessarily rise as the market drops, or fall as the market rises. In fact, often it's the exact opposite.

The reason is because traders in S&P 500 index options are mostly institutional, so the options activity is often a hedge against underlying portfolios. So when stocks rise, we often see more demand for put protection, not less.

We also show a 5-day Rate Of Change for the Fear Barometer. It turns out that these traders can be pretty savvy short-term market timers. So when we see a sharp upward spike in the Fear Barometer, it means that traders are quickly bidding up put options, and the S&P 500 often sees a short-term decline soon afterward.

Conversely, when we see a sharp contraction in the Barometer (and the Rate Of Change drops to -10% or more), then we often see the S&P rebound shortly thereafter.



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