Markets rarely move in a straight line, and the stories behind their fluctuations are often far more complex than a simple news headline suggests. For seasoned traders and market watchers, understanding not just where a market could be going, but how certain – or uncertain – traders feel about it is crucial.
Two powerful, yet often seemingly conflicting, volatility metrics derived from the CME Group CVOL Index offer this insight: the skew ratio and convexity. By examining these metrics together, we can move beyond directional views and peek into the level of conviction and protection buying among options traders.
For a quick primer, let's look at what each metric signals:
- Skew Ratio, or Directional Sentiment: This metric gauges the balance of variance between call (upside) and put (downside) options. A ratio above 1.0 suggests greater variance in calls, signaling a likely bullish or upside directional sentiment. A ratio below 1.0 implies a bearish or downside sentiment.
- Convexity, or Market Uncertainty: This measures the degree of variance in options out-of-the-money (the "wings") compared to those at-the-money. When convexity increases, it means traders are buying more protection on the extremes, signaling a spike in uncertainty and fear of a potentially significant, unpredictable move.
Separately, they tell half a story. Together, they reveal the market’s inner conflict. Here are three examples of the skew ratio and convexity moving together.
1. The Euro Rally & Tariff Turbulence
During the early and mid-2025 period, the Euro futures market saw notable shifts in direction and volatility. A rally in Euro futures that began in early March 2025 was accompanied by a rapid increase in the skew ratio from 0.90 to 1.05. This coincided with a spike in convexity and subsequent decline, reflecting the introduction of tariffs and the resulting uncertainty in the FX markets. By April, convexity increased again, signaling that the market was pricing in an imminent move, with the skew ratio indicating a likely upside trend in the underlying futures market.
2. Wheat’s Volatility Amid Geopolitical Conflicts
As the Russia-Ukraine conflict continued in October 2022, wheat prices rose from around $7.50 per bushel to just above $9. This uptick in prices coincided with an increase in the skew ratio, reflecting a bullish sentiment. However, the rise in convexity indicated that traders were becoming increasingly uncertain about the market's direction. The continued elevation of both metrics in early November suggested that traders were buying protection against potential price movements on both the upside and downside, not just expecting the rally to continue.
3. Copper’s Tariff Tug-of-War
A back-and-forth news cycle in April 2025 about proposed copper tariffs caused market participants to seek protection against potential price increases, as copper is used in many critical industries like construction, electrical infrastructure and energy. This was reflected in a rising skew ratio of the front-month copper futures. However, convexity also increased at the same time, suggesting that even while many were anticipating an upside move, there were conflicting sentiments in the market.
While the skew ratio can indicate potential directionality in the market, convexity is still an important metric to follow for gauging uncertainty and price of risk in out-of-the-money options. Examining these different views of market sentiment may offer greater market insight.
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